All eyes will be on crucial US economic data this week. As markets try to determine the outcome of the upcoming US Federal Reserve rate decision on September 17-18, Paul Flood head of mixed asset investment at Newton Investment Management, discusses ways traders could find rates policy opportunities and why desks should be paying close attention to emerging markets.
Flood looks at the recent volatility around large-cap firms, unpacks what he’s seeing in liquidity across risk assets, and shares his views on US versus EM equities valuations.
In this episode, the head of mixed assets also discusses how he’s thinking about the potential US election volatility in November and shares his concerns about growing government debt and the wider implications on markets.
Interview transcript
Jo Gallagher Welcome to Trader TV This Week, you’re insight into how trading desks can prepare for the week ahead, I’m Jo Gallagher. Today I’m joined by Paul Flood at Newton Investment Management to discuss the main topics and events leading this week. Paul, welcome to the show.
Paul Flood Great to be here.
Jo Gallagher Set the scene for us. What can we expect from the upcoming week and how should trading desks be preparing?
Paul Flood Well, markets are going to be digesting the news flow from last week. We had the ISM services sector data, which came in a little bit ahead of expectations. That Job Openting and Labour (JOLTs) data and then we had the Non-Farm payrolls on Friday, which came in at 142,000 so slightly below the 165,000 that was expected. So as we get the inflation data later this week, as long as that doesn’t come in higher than expectations, the Fed will start rate cutting. The question is, do they go for 25 basis points or 50 basis points? And if we look at the wider economy, the Beige Book came out last week, that started to show a deterioration across the economy and we’re starting to see that come through in corporate earnings as well, where the lower-end consumer is really starting to struggle.
That will then lead to corporate restructuring, job cuts. So if the Fed wants to get ahead of the curve they really need to go for a 50 basis points rate cut to start with to give them a little bit more leeway into the end of the year and make sure they’re not behind the curve. Then that should relieve markets and perhaps lead to a rally in risk assets, maybe towards a weaker US dollar, which would be good for emerging market equities as well.
Jo Gallagher As we reach this inflection point in the global rate cycle, how can traders make the most of the volatility and the timing around global policy decisions?
Paul Flood Well, I think, you know, the markets were very skittish at the beginning of August as the Yen carry trade unwound. We’ve now got policy divergence. We’ve got most Western Central banks cutting interest rates and the Japanese central bank is increasing interest rates. And that should be positive for the Yen. Now at the beginning of August, that led to an unwind of some of those growth and tech sectors. So we may see a bit of that again. And that volatility can create some opportunity to add into areas of long-term structural growth if you’re willing to accept that volatility.
The Yen may continue to rally, given those rate differentials but if we look at the CFTC data on non-commercials, we’ve gone from a net short Yen position to a net long position. So it’s unlikely that we’ll see those aggressive moves that we saw at the beginning of August. But given we continue to see rate differentials close, we may find that some of the Japanese domestic investors want to bring some of that money back home onshore to take advantage of higher interest rates in Japan.
Jo Gallagher We’ve had a lot of volatility around equities recently. What has liquidity looked like across risk assets, and what is your outlook for large cap valuations?
Paul Flood Well clearly valuation in the large cap and the tech companies is pretty high and if you think about the growth that’s come through, they have delivered on that. And if they continue to deliver on that and there are lots of reasons why they would, given the move towards AI. Then they should be able to justify those valuations. We have had a lot of volatility and that is an indication that people are nervous of those higher valuations. Now liquidity conditions in the market aren’t great. There’s not a lot of depth to order books.
But when you look at the valuations in emerging markets, you know the emerging market index is trading on 14 times earnings. You know the US market is trading on 24 times earnings. So there’s a big divergence there. And when we look at flow data you know we’ve had $60 billion out of emerging market funds over the last two years. And so when we think about interest rates and the US starting to come down again, that tends to be favorable for emerging market equities, particularly when it comes with a weaker dollar. So if we do get a 50 basis point rate cut, and it’s not because people think we’re going into a hard landing, then that should be quite positive for emerging markets.
Jo Gallagher With a US election coming up. Are you concerned about election volatility in November, and are you seeing any signs in the data on how markets are thinking about this?
Paul Flood Well look it’s always a concern. It’s very difficult to predict. But ultimately for us sometimes that volatility can be your friend. If you go back to the Taiwanese elections and the run-up, the rhetoric between China and Taiwan, that was a great opportunity to increase positions in companies like TSMC, which was one of the highest-quality semiconductor manufacturers in the world.
And whilst the rest of the AI train was on fire, TSMC, which is a great beneficiary, didn’t see that because of that rhetoric around China and Taiwan. And so for long-term investors, it can provide opportunities to pick up some companies that are long-term structural winners irrespective of who gets in. But ultimately, in the longer term, you know, corporates, management teams will adjust to whatever new policy comes through with the new government.
Jo Gallagher How concerned are you about the global deficit picture and the long term implications on markets?
Paul Flood Well, I think budget deficits globally are an issue that will need to be sorted out post the election, particularly in the United States. If you remember in 2022, in the UK budget, the bond market revolted some of the unfunded spending within that budget. And that’s going to be a problem for the US as well. The US is running a 6 to 7% budget deficit, and that’s going all the way to 2030.
Probably a reason to be very cautious of the long end of the bond market. And a lot of that is non-discretionary spending. So we are going to have to think about how that’s covered. Now if we have good growth then that might be okay. But it will become a problem if we go into a recession and we haven’t got control of those budget deficits, because it’s not just a problem for the bond markets, it will be a problem for risk assets as well, which will be priced of the US ten year Treasury. That fiscal deficit concern will be a problem for next year, but it’s certainly something that investors should be thinking about going forward.
Jo Gallagher Thank you, Paul, for your insight and of course you for watching. This has been Trader TV This Week.
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