Last week we spoke to Economist Andrew Hunt who painted a picture of a weakening U.S. economy which could result in lower rates but then the potential for more fiscal stimulus by the incumbent administration. Essentially, this is the 'muddle-through’ scenario whose probability is supported by reflexive mechanisms - a softer economy and or lower inflation allows for more government support, and vice versa. 

The counter point discussed was that this sanguine view could easily be overtaken by political events and that the consensus around such this election year muddle through/soft landing scenario is so well established that, were it to be disturbed, the market could become quite volatile. Within hours, the first U.S. Presidential debate had underscored this point. For now equity markets are relatively unmoved but bond markets have taken note. In Europe the equity markets also settled at the prospect of a concerted push from the centre and (ironically) the left to ward off the prospect of another populist, right wing, big spending, low taxing party. While our focus for now is on what happens for the remainder of this year, the direction of travel in 2025 and beyond is perhaps becoming clearer in ways that might entail higher long-term rates and may not always be so market friendly. 

The current economic situation in the United States and pretty much everywhere else is also characterised by the so-called K-shaped recovery where low-income groups have been left behind. This bifurcation in economic experiences is likely to be a key factor in shaping fiscal policy decisions in the run-up to the election and beyond. With the potential for a Trump administration that favours expansionary fiscal policies, markets may need to brace for significant changes. One of the primary concerns is the potential for a substantial fiscal stimulus. The market is already anticipating a significant budget deficit, with forecasts suggesting a trillion-dollar deficit over the next three months. This expectation, combined with the possibility of even more aggressive spending under a Trump administration, could have several implications:

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1. Inflation risks: While the economy has been experiencing some disinflation, a large fiscal stimulus could reignite inflationary pressures. This is particularly concerning given that capacity utilisation hasn't fallen as much as anticipated, and some persistent inflationary factors remain in play.
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2. Bond market pressures: As the government potentially issues more debt to finance increased spending, bond yields could rise. This could lead to a reassessment of risk in the markets and potentially trigger a slowdown in economic growth.
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3. Liquidity concerns: The current market optimism is partly based on the expectation of monetizing the budget deficit through various means, such as drawing down reverse repos. However, these tools may be exhausted by Q4, potentially leading to funding challenges in 2025.
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4. Market volatility: The consensus view of a "soft landing" supported by fiscal easing may already be priced into the markets. This leaves room for disappointment if the stimulus doesn't meet expectations or if it leads to unintended consequences.
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5. Private credit risks: The analysis highlights significant concerns in the private credit market, with potential hidden leverage and risky practices reminiscent of pre-2008 financial crisis behaviours. A change in economic conditions could expose vulnerabilities in this sector.
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6. Global economic factors: The potential for a more isolationist or protectionist stance under a Trump administration could exacerbate existing global economic challenges, including struggles in Japan and continued deterioration in China's economy.

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Also of note in the conversation was recent data from Taiwan suggesting a potential slowdown in the semiconductor cycle, which could impact tech stocks that have been driving market performance. 

Overall the next six months could see increased market volatility as investors grapple with the implications of potential policy shifts, inflationary pressures, and hidden risks in certain market segments.