A Game of Two Halves

Politics – Out with the old

The biggest development on this side of the Atlantic is Andy Burnham's imminent arrival as Prime Minister. From my perspective, this matters on two levels. First, from the view of global investors, understanding policy priorities and how they're financed will be crucial for the gilt market. Second, as somebody working within the UK wealth industry, I'm interested in what it could mean for taxation, regulation and the broader competitiveness of UK financial services.

The early indications on personnel have been encouraging. Shabana Mahmood appears set to become Chancellor, trumping the more fiscally loose candidate Ed Milliband, which is likely to reassure bond investors. This suggests fiscal discipline will remain a priority, something that should be welcomed by gilt markets, in a continuation of the stability that Rachel Reeves has tried to introduce.

That said, we've heard relatively little in the way of concrete policy detail. Much of what has been discussed so far – defence spending, infrastructure nationalisation, council housebuilding – sounds expensive. How those ambitions are funded will matter enormously. Equally important will be whether the government can articulate a credible plan to support business investment, economic growth and the UK's position as a global financial centre.

Across the Atlantic, attention will increasingly turn towards the US midterm elections. Every seat in the House of Representatives, a third of Senate seats and 36 governorships are up for election.

The expectation among pollsters and betting markets is that control of Congress will shift from Republican to Democrat hands in both chambers, while the gubernatorial picture looks like more of a toss-up. Given the Executive will remain Republican, a Democrat legislature will lead to gridlock: no bad thing for markets as a divided government generally reduces the likelihood of dramatic policy shifts and can help impose greater fiscal discipline at a time when deficits are already ballooning.

However, there is a more interesting question lurking beneath the surface. If Congress becomes a greater constraint on the White House, does President Trump revert to more reliance on executive orders? And what happens when those executive orders see pushback? Recent Supreme Court decisions to strike down the administration's use of the International Emergency Economic Powers Act (IEEPA) to impose tariffs suggest there is already meaningful pushback from the judiciary. If that resistance starts to come from both the courts and Congress, policy uncertainty could well increase rather than decrease.

Inflation: Are Markets Too Relaxed?

Finally, there's inflation.

At the moment, markets appear remarkably relaxed about inflation. It strikes me that the conflict in the Middle East has not actually concluded yet – and although discussions are ongoing, they are very stop start with unclear ramifications for global supply chains. That said, judging by bond market pricing in inflation breakevens, investors seem increasingly comfortable with the view that inflation is not about to streak higher any time soon.

Maybe? But it's worth remembering that inflation shocks rarely arrive immediately. The inflationary effects of the Russia-Ukraine conflict took considerable time to feed through into energy prices, supply chains and ultimately consumer prices. Today's situation is different, but the principle remains the same.

The encouraging news is that interest rate expectations have already adjusted higher. If inflation continues to ease gradually without reaccelerating, some of those expected rate rises could be removed from market pricing. That would be a very constructive outcome for equities and other risk assets.

As ever, nobody knows exactly what the next six months will bring. But I reckon that these three topics will be driving attention for market participants over the next few months. Given what we’ve already seen year to date, hoping for a calmer second half seems wishful thinking!