With politics it’s prudent to expect the unexpected

This all came to a head in autumn 2022, with Liz Truss and her government’s market-shaking Budget. To this day, what Macbeth is to thespians, Truss is to gilt fund managers – merely mentioning her name is considered bad luck to superstitious gilt fund managers (although we’ll risk it here).

While Rishi Sunak’s tenure has given markets a breather, there’s no doubt 2024 is the year of politics. Some 64 countries, covering around 49% of the global population, will hold elections, but only two matter for us.

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In November, Donald Trump will face President Joe Biden in a rematch few voters apparently want. Meanwhile, the UK General Election is pencilled in for autumn although could come as late as January 2025. Regardless of its timing, the next election is likely to usher in a Labour government.

What do we expect from the Labour Party? If the economy was in a better place, we think Labour would spend when it came to power. Starmer and Reeves, however, understand that unfunded spending sprees are inadvisable.

Reeves calls her brand of economics “Securonomics”. She sums it up as “economic security, stronger family finances and good jobs first”. While we’re not entirely sure what that looks like in reality, it’s unlikely to break the economy or put a flame under already hot inflation. And, unlike September 2022’s Budget, it shouldn’t propel UK gilt yields to the Moon.

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We do expect the state to play a far more active role under a Labour government, particularly in industrial strategy. Green energy and green industries will take centre stage and we’ll see deeper collaboration between the state and private enterprise. All this will take place under the banner of fiscal responsibility.

As for spending and fiscal headroom, the Conservatives have left the cupboards bare. The government can easily change fiscal rules, and we expect Reeves to do so at some point, although her adjustments will be monitored and measured. She’ll be aware that the market, particularly international investors, will scrutinise any fiscal changes. The impact of ex-chancellor Kwasi Kwarteng remains fresh in many people's minds.

Labour can’t ignore the annual gilt remit (the number of gilts the UK needs to sell to fund its spending). That number is already sky-high. The market will adversely react to any significant increase. In short, Labour will need to offset any additional spending. And that means tax hikes.

The saving grace is they should have time to enact their policies. We expect Starmer and Reeves will have time to lay the groundwork and hope the economy allows them the breathing space to make more fundamental spending plans further down the line.

What does this mean for markets? As it stands, not a lot. As we edge closer to these elections, all eyes are on central banks. While the commencement of rate cuts has been delayed, our view has not changed: central banks will cut, yields will come down, but patience is required.

The US election, however, does have the potential to move the market. While Donald Trump vs Biden looks like it will be a tight race, a lot could happen between now and November. US data has been more resilient than markets expected. Unlike the BoE, we think the Fed will be mindful of the upcoming election.

According to market pricing, the first cut has already been pushed back from March to June. If there’s any further delay, the Fed will have to decide whether it wants to reduce rates so near to a highly-volatile election. We wouldn’t envy Fed chair Jerome Powell’s position if that came to pass.

After the election, markets will face either Biden’s spending plans or more Trump tax cuts. Platitudes aside, neither seems overly keen to tackle the US’s ballooning deficit. Both approaches would hinder the Fed’s ability to cool the hot US economy.

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As investors, it’s our job to anticipate the future, but with politics it’s prudent to expect the unexpected. That could cover scenarios ranging from a shock Conservative victory to a return to a coalition government. If Labour do win as widely expected, are we 100% clear on what Reeves and Starmer will do? No. But will they act in Truss’s cavalier manner? Highly unlikely. Over in the US, the election will be market moving. Are investors currently focusing on the result? No. Will they? Definitely. We’re in for an interesting year.

Matthew Amis is investment director, rates management, at abrdn