Markets could be in store for a rocky week, as thinly staffed trading desks try to digest the news of Biden’s announcement to withdraw from the election race late on Sunday, July 21, buckling to widespread pressure from the Democratic party to step down as the party’s nominee. Phil Milburn, fund manager at Liontrust Asset Management, spoke to Trader TV ahead of the announcement and warned of major political volatility ahead (Question 2 onwards) and the need for de-risking portfolios over the next few weeks (Question 3).
In this episode, Milburn unpacked how the summer slowdown could be ripe for exaggerated market moves; how he sees politics and economics driving trading activity this year; what a Trump presidency could mean for markets, and how to prepare for election volatility in November.
He also drilled into whether he sees the recent US stock rotation as purely a “blip or a longer-term trend” and how he expects bond yield curves to play out in 2024.
On the other side of the Atlantic, the fund manager covers his outlook for the UK and European Union’s interest rate cycle and war against inflation.
Finally, Milburn shared his concerns on broader market liquidity and why he fears a potential “liquidity-based accident” sometime this year.
Interview Transcript
Jo Gallagher Welcome to Trader TV This Week your insight into how trading desks can prepare for the week ahead. I’m Jo Gallagher. Today I’m joined by Phil Milburn at Liontrust Asset Management to discuss the main topics and events leading this week. Phil welcome to the show.
Phil Milburn Thanks, Jo.
Jo Gallagher To start with, what’s important for trading desks to be aware of going into the upcoming week?
Phil Milburn Obviously we are now in the thin summer markets, but by definition in thinner markets you can have more exaggerated stock moves. Anecdotally, it seems that quite a lot of the counterparties that we deal with have been flattening their books ahead of having their compulsory two-week holidays. So there’s a lot more liquidity focused on just a few remaining brokers who have not yet gone away for their vacations.
But that does mean there will be opportunities for both the buy side and sell side to extract value. One of the things that we’re always told is people tend to load up on yield, on carry for the summer. That’s always a dangerous trade because quite often as you come to September, markets have a wobble. Hence, a slight de-risking theme over the next few weeks is what one should expect to see.
One of the key themes in the market has been an enormous sector rotation started very much, I believe, by the interest rate cycle, particularly in the US. And what we’ve seen is the Russell 2000 Small Cap Index outperform the Magnificent 7 by over 10% in the last couple of weeks. Now that’s just a blip on a longer-term chart over the last three years. Magnificent 7 is still 90% ahead, but there’s going to be big tension in the market trying to work out whether this is the start of a great rotation or just a blip on a long-term trend.
Jo Gallagher And how are you positioning and putting on trades amid this backdrop in this kind of economic versus political dynamic?
Phil Milburn At the moment, the economic side of the equation is very supportive for the bond markets. We’re approaching the stage where the US Federal Reserve can join other developed market central banks in beginning to cut rates. And it looks like most of the Fed officials are starting to pencil in a cut for September. That’s partly what’s been causing this market rotation.
That very much hints towards steeper yield curves, as does the politics with the overhanging threat of Trump being elected in November. And we’ve already seen some of this manifested within the bond markets, with both the difference between the US two-year and ten-year becoming less inverted, moving from -50 basis points to -25, and the difference between five-year and 30-year bonds in the US as well, increasing by 20 basis points.
So positioning, I continue to think the yield curve steepeners, long-dated bonds underperforming short-dated bonds have a long way to go. The hard bit of the equation is the level of the bond markets, and the politics will add increased volatility there. Finally, from a fixed income perspective on the credit side, I continue to believe that credit is priced for perfection and as we enter these summer months and a lot of our counterparties are flattening their books, I don’t think it’s a good time to be just taking carry chasing yield. I think it’s a very good time to be de-risking and getting a better chance to buy once there’s a little more risk premium within the credit universe.
Jo Gallagher What would it mean for markets to have a Trump administration? And how would you be advising Trading Desk to prepare for any election volatility in November?
Phil Milburn So there are three big Trump policies that he’s made the markets aware of. Firstly, there is increasing tariffs, which is obviously very inflationary and long-term negative for growth, disinflationary from that perspective but does help with the fiscal deficit. His second policy is about curbing migration and that is inflationary, and again negative for growth. And then his third is rolling over the tax cuts which will obviously boost the fiscal deficit but will boost growth and probably boost inflation.
So from the Fed’s perspective, the economic data is supportive of rate cuts. And ultimately if Trump does get it in November, it will not stop the Federal Reserve from cutting rates. It will just impact the terminal rate that they will get to, i.e. the neutral level. So we’ll still see rate cuts. We’ll just see fewer rate cuts than somebody else in the Democratic Party becomes the next president.
Jo Gallagher Looking at this side of the pond. What is your base case for Europe?
Phil Milburn It seems bizarre to say the U.K. is now a bastion of stability. Everything is relative within the markets anyway. So post the most recent data that we saw last week on both the UK labor market and UK services, inflation is going to be an incredibly close call whether the Bank of England cuts rates on the 1st of August.
The markets realize it’s very close and are priced at 50/50. But the exact timing doesn’t matter that much because by the September meeting, if the MPC skips cutting in August, there’s a 90% chance of a cut then occurring in September.
A similar theme from the ECB, whose meeting last week was very much a nonevent, as was Lagarde’s press conference. Very much data-dependent but there’s still 80% chance that the ECB now cuts rates in September. So the rate cycle is definitely turning. Slow progress. But inflation continues to trend in the right direction which will empower greater cuts towards the end of the year.
Jo Gallagher What is your outlook on broader market liquidity over the next few months, and what should trading desks be paying attention to?
Phil Milburn So one of the things that I think the market is not focusing on as much as it should, is the shrinkage in the Fed’s reverse repo (RRP) facility. What this really means is that money that was off-market has been brought back on the market via the channel of money market funds by the shrinkage of the RRP, by just a little under 2 trillion over the last 12 months, down to 400 billion left outstanding.
That has created a huge injection of liquidity. Now that’s a gross amount. The net amount hasn’t been quite as much because the Fed has its ongoing quantitative tightening. What that now means now that the RRP has shrunk so much is quantitative tightening, even at its reduced pace, will be so much more potent than it was before.
So something to watch for, not in the next few months, but possibly sometime this year, is a liquidity-based accident, similar to one we saw during the Fed’s QT one period during 2018-2019. Not definitely going to happen, but a risk that I believe is under priced in the market.
So I believe in all risk markets, both credit and equities, one will get a better chance to buy. So I would use these thin summer markets as a chance to take a little profit, take some risk off the top, and look to reset in any risk wobble potentially caused by this liquidity crunch later in the year.
Jo Gallagher Thank you both for your insight. And of course, you for watching. This has been Trader TV This Week.
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