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US elections and the search for a risk free asset

1 November 2016 by

The US election campaigning has been nothing short of sensational. As a patriotic American I have listened to the ever unfolding rhetoric with shock and fatigue and can understand why the world is following this race with real concern. We appear to be confronted with candidates that seem set on self-destruction with a varying combination of isolationism and anti-business rhetoric.

So what impact will the US elections have on the market? As we approach the vote it is understandable why markets are cautious, however the aftermath may be more benign than many in the markets fear. Despite campaign promises of wall-building, rewriting free trade agreements, reversing healthcare reform, changing tax schemes and continuing to attack Wall Street, the reality is that sweeping change is difficult, even for a president.

A key factor in the potential scope for change will be which political party controls the presidency, the House and the Senate. Without control of all three, it will limit the ability to implement sweeping change; and even in the event that Trump does win a majority, he has created such divisions within his own Republican Party that he is unlikely to gain support from key required figures.

That said, we do think there is the potential for a degree of market volatility, so we are positioning the portfolio accordingly and adopting a balanced approach as we enter this critical time. This does include an increase in the risk-free allocation, which has challenged the PM team given the recent breakdown in correlation across the varying sectors within fixed income. We have continually debated what is the best risk-free asset into this year end. The traditional answer is US Treasuries but with >70% probability of a rate rise at the December FOMC is it the appropriate risk-off asset? We concluded that given the benign threat of a sharp increase in US inflation the long end of the US Treasury curve still represents a flexible risk-off asset into year end, and have therefore increased our allocation ahead of the US election.

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