Lukasz
Hello and welcome to Sound Bites Fidelity's monthly podcast where we talk about all things investments. My name is Lucasz de Paubaix and I'm from Fidelity International and I'm pleased to be joined this month by Fidelity's Global Head of Macro and Strategic Asset Allocation, Salman Ahmed.
Salman has over 25 years of investing experience, holds a PhD and Master of Philosophy in Economics and Finance from Cambridge. His role at Fidelity sees him and his team oversee our broader global macroeconomic inputs that feed into our various investment teams, as well as our strategic asset allocation process. We're excited to have someone of Salman's calibre on the show. Welcome, Salman.
Salman Ahmed
Thank you, thank you for having me.
Lukasz
And before we get into the nitty gritty and today's discussion, not surprisingly, is really going to be focused on the big event everyone's talking about, and that is the US election. But before we get into that, I'm always interested in the people that I speak to. And one of the things I know you're very passionate about is cricket. And from what I understand, Australia is playing Pakistan tomorrow in Sydney, I believe.
Salman Ahmed
So definitely, mean to be fair with you, I have lot of respect for the Australia team. I wish my team could learn a thing or two from the Aussies. But yeah, mean, Pakistan is Pakistan, so I don't know if you follow the series against England. We beat them for you guys, so you then go into ashes with a different perspective. But yeah, it's still every team's dream to beat Australia in Australia, and I hope it will happen in my lifetime.
Lukasz
Yeah. Yeah. Yeah. Well, we'll see what happens. And yeah, good luck to both teams, I guess. But let's kick off the podcast because if we sort of start off with things and it's been an interesting couple of days, there's been a little speculation, you know, who's going to win. The pollsters were saying it's going to be a very tight race. Now it's actually ended up being a resounding win for the Republicans, winning the popular vote, the Senate, and I believe they've also won the House as well. So pretty much full control and a pretty broad mandate in terms of their policy agenda. And I guess in terms of the policy agenda, what are some of the key things that you believe we should be watching and observing in terms of policy, particularly from a macroeconomic perspective?
Salman Ahmed
Sure, no, definitely, as you mentioned, Lucas, I think the final results are that President Trump has outperformed the polls by two, three percentage points across the board. that's the challenge for the polling industry. I think they are getting it, or his nature of his support, wrong now consistently. But that's for the polling industry to sort out. But the betting mark is, to be fair with you, for most period over the last few weeks have been around plus 60 % plus and then they had this volatility going to the elections. But, you know, on general the tilt has been, had been towards a potential Trump victory. But also I think one of the scenarios which was probably under-priced was the 'Red Sweep'. So which is that, you know, if President Trump wins it was very likely as well that he would carry with him the down balance.
That said, obviously the election was much more comfortable, but the House came very, very close and it's likely the majority in the House of Republicans may be smaller than last time around. So there are some nuances there. But the reality is that we are looking towards a 'Red Sweep' which is quite different from a divided government when it comes to fiscal policy. So there are two, I think, components of macroeconomic policy we are focused on, have been focused on for many months now. We've done a lot of work on what happens if tariffs are put in as they are being discussed. We've also done the work on fiscal deficits impact and then growth impact as a result of the policies which were being discussed on the campaign trail. So all in all, the tariffs rate which I talked about is 60 % in China, 10 to 20 % on the rest of the world, depending on which speech you pick up. But these are significant numbers. And on fiscal policy, given that we have a red sweep, that means tax cuts can happen, the extension of TCGA can happen. There is no talk of fiscal pragmatism in any of the campaigns, both campaigns, Democrat or...or Republicans, but in a 'Red Sweep' scenario, know, in fiscal deficit, the US can go above 8%, which is very significant, obviously, compared to pre pandemic period, but also very abnormal when you look at, you know, years outside of recessions.
Lukasz
Yeah.
So if we think about the tariffs, because that has been a point that has been discussed extensively, it's sort of interesting because if you think about the first Trump presidency, we obviously saw some tariffs coming in. Over the Biden presidency, it's fair to say that that policy has been continued somewhat. So with the policy and Trump has been very vocal around putting tariffs on things, what are, if that was to occur, and I guess we went to that maximum position that that Trump's been talking about on tariffs, those higher tariffs, what are then the possible implications for the broader economy? Because we know over the last couple of years, we've been battling inflation, Central banks have been obviously trying to get a handle of that. What do higher tariffs, if we do see them, mean for that aspect of the economy?
Salman Ahmed
Sure, our assessment is that if tariffs are done as they are being discussed, although there is a discussion to have whether, how will tariffs be put in place? I think that's an important discussion to have as well. But let's assume that to your question, Lucas, that tariffs are done 60 % on China and 10 % on the rest of the world. So our assessment is that that gives one-off shock to core inflation of 300 basis points. So US core inflation shock is up to 300 basis points. Now that's a one-off shock, but that can become a sustained shock, depending on how it shocks inflation expectations: are tariffs permanent, are they a part of negotiation, or broader negotiation strategy, and then how does the Fed react to it?
Lukasz
Right.
Salman Ahmed
which is also important because of potential deterioration in the relationship between a Trump presidency and administration and Fed will have consequences both on inflation expectations and potential real rates as well. So it's a significant change and just to give you perspective, China tariff rates pre 2017-2018 were around 1.5-2%. They went to 10%. But now we're talking about bringing 10 to 60. So this is not about tariffs, it's also about the rate which is being discussed. And these are significant rates. So as I said, I think we see 300 base point as an upper ceiling estimate.
Salman Ahmed
And then we think about, okay, what are then the scenarios, how they're get placed, are they gonna be done incrementally, are they permanent, are they part of a, as I said, broader negotiation strategy, then the shock can transmit itself differently to one of big 300 basis point shock.
Lukasz
And if you think about, guess you mentioned China and we saw China undertake, I guess, a pretty significant stimulus in September. The initial market reaction was positive. However, some of that excitement around that stimulus has fizzled out. Now, the market has been really sort of waiting now and saying, well, what's physical stimulus going to look like in China? Do you think that the changes in the US government, the possibility of high tariffs on China - Do think that is going to have any implication as to China's next move in terms of things like fiscal stimulus?
Salman Ahmed
I mean, it may impact the timing. To be fair with you, even without tariffs, China needs stimulus. And we saw the pivot in September start to take place. And it came on the back of a run of weak data, especially credit data. So credit demand has been missing in China. And that is a very broad-based warning sign linked with the lack of domestic demand. And then that plays into employment.
So I think, yes, there are implications. So we have the NPC (National People's Congress) tomorrow, which I think will give us more detail in discussion. But please remember that China will need stimulus for many, many quarters ahead. This is not a one-off quarter thing. So I think they'll have to think about how they calibrate the numbers, how they manage expectations, because the economy will need support for many quarters to come as this balance sheet issue gets resolved.
A stopgap stimulus is what worries the market and rightly so and that can undo the progress quite quickly if it's stopgap. So the data risks complicated the picture but I don't think they are the primary driver. They basically, know, amplify the need for a thought out fiscal rather than triggering a fiscal, if you see my point.
Lukasz
Yeah.
Yeah, no, absolutely. And if we think about outside of China, and I know from an Australian perspective, there's been a lot of early discussion around what does it all mean for Australia in terms of from a trade perspective, any views from yourself around more broadly beyond China? know, many, many governments will be reassessing what it means. How do they deal with this new presidency and the different policies? What are the possible implications beyond China in terms of trade, sort of more potentially more protectionist type of attitude. What does that mean?
Salman Ahmed
Sure, so I think obviously in Asia Pacific part of the world obviously the focus is on China as you rightly pointed out Lucas. But I think it's also Europe. Europe is not our, Europe is the second. In fact I would say more exports to all this than China. Because Europe like China is an open economy, they are export focused as well. Both of them have current account surpluses with the US.
Now rightly and wrongly a Trump administration or Trump thinking, Trump, you know, overall thinking is that, know, current account deficits are bad. You can argue, you know, the mechanics of that argument. But Europe is the other one. And then another angle where Europe gets exposed is geopolitics. So you have two conflicts as well running, Ukraine-Russia and then obviously in the Middle East as well. on Ukraine and Russia, some of the views of Trump campaign have been very much more clearer than they have been on the Middle East conflict, which is more complicated and complex as well, given you have multiple stakeholders involved. So I think there is a security angle there, obviously a tariff angle from the policy perspective, and then the more medium term structural angle that, you know, the idea that the first Trump presidency was one of, has been destroyed, right? So is it, you know, start of a more structural trend of protectionism? It has to be also be thought out because the responses will be different, right? If you think these are, these issues are here to stay. And as you mentioned earlier, the Biden administration put, you know, when it came in, in 2020, did not undo the tariffs. They maintained them right. So that also gives a signal value that whatever changes happen may have staying power.
Lukasz
Yeah, yeah, absolutely. And then from a market perspective, it's interesting because obviously a lot of the focus has been on the, you know, what are the possible implications of macroeconomics and so forth. But if you think about the markets, just after the elections, we saw the US market rally quite hard. If we look at previous elections, that tends to be a common, common early phenomenon where I guess markets like clarity, they like certainty. I mean this time around it was pretty clear cut. The result came through pretty quickly. But further afield, do you think from a market perspective this presidency will impact markets, if at all?
Salman Ahmed
Sure, so I think we have to look at the rates market very, carefully because I think they will be very sensitive to any fiscal deployment, the nature of it, the size of it. I think it will take months and months before you get the clarity because a new administration doesn't get into the White House and the new Congress is not sworn in till Jan of 2025. So we will have to go with the expectations, and the immediate next step is who's going to be in cabinet, treasury secretary, the key appointments. I think they are going to take a lot of focus. And I think, yes, think the pressure on rates is likely to be on the upside.
Dollar does well, I think, in this environment because of tariff risks. Again, you can argue the form and shape of the tariffs, and we'll have a lot to say about it, I think going forward but the dollar does seem to be the clearest barometer of that trend.
Then equities are interesting in the sense they rarely no matter what. They have been in that phase because there have been other multiple things happening as well beyond presidential elections as you know very well.
So I think there we have to be thinking and thought about the sectoral implications, which sectors may benefit from deregulation. We have seen financials do very well. And I think that trend can continue. Rate sensitive sectors may come under pressure on a relative basis. But overall, you are looking at a normal GDP upswing here, right? And I think if you look beyond the first stage of it, the second stage is how the Fed reacts to anormal growth going to 7%, right? Already US growth was around 3 % real growth, right? It can easily go to 4, and then inflation can go back above 3. So you're talking about 7 % plus normal growth. So the question is, can the Fed cut when normal growth is running at 7 %? Do we have to think about hikes again? Maybe a bit early to think about it. But those are the stage two questions in 2025. And then equities may not like it. But right now we are in stage one, which is reflation or what I call 'Trump-flation', which is basically policy-driven reflation. This is not a natural cyclical phenomenon. This is potentially being, using the policy to pull everything up and also do some transfer of growth through tariffs you basically transfer growth back to the US from Europe and China.
Lukasz
Fantastic. And if we think about the broader macroeconomic environment, and one of the things that I know you and your team look at quite closely is looking at, you know, what does the future environment maybe look like? And you do have a couple of scenarios that you look at. And one of those that has been quite prominent is this concept of a soft landing scenario.
And that has been, I guess, Fidelity's most probable scenario for the last little while. How do you think from, you know, if you think about that scenario, what are the risks to that soft landing scenario potentially going forward with this new presidency coming in?
Salman Ahmed
So think the clear risk is upside risk. During summer we were playing with the recession soft landing spectrum and we held on to our soft landing view mainly on the flow of the data on consumption patterns we are seeing. Labor market was slowing but it was not falling off the cliff. Obviously there was a lot of reaction on the basis of non-farm payrolls release, monthly non-farm payrolls release, but they tend to be very volatile and subject to revisions. So you are basically forecasting a data with errors and you don't know about these errors till like six months or a year later. And these errors are significant. So the last benchmark revisions were up to million jobs. So, you know, but the Fed has been focused on it because they said, we are data dependent, but you are dependent on quality data. So, we were looking at the holistic range of labour market data and it gave us a signal that, you know, it's slowing, but it's not falling off the cliff. And in level terms, still a very strong labour market in level terms. So, we stuck to our soft landing view as it was tested during summer. But now as we are moving towards 2025, obviously we have to think about the impact of these economic policies. We'll have to make a judgment on at least what the base case would look like. But here, think it's pretty clear the direction of travel is, as I mentioned, nominal GDP upswing, which means that you have to think about a Trumpflation scenario, which is a mixture of reflation, and the critical question how the Fed responds to that once as it starts to get know bedded in. It's too early for them to comment on it or think about it, but obviously a fiscal policy stimulus which takes your deficit from 6 to 8 is a very significant one, and tariff rates as I mentioned you know are not incremental increases right.
Salman Ahmed
So I think we are basically, as we think about 2025, be punching up probabilities of what you can, know, what looks like reflation, but has policy centricity around it. And I think to my mind, a recession in the US now happens if the Fed responds to all this. So it's a different sequence now compared to, I think, if we had a Harris administration, for example.
Lukasz
And maybe on a final point, I guess, you know, there's a lot of moving parts. Obviously, there's geopolitics, there's change in presidencies, there's, you know, things that have been impacting markets for some time, such as, you know, inflation. Where are you the most optimistic? If you think about the next 12 months or the next, you know, 2025, what areas are you the most optimistic about?
Salman Ahmed
So I think the areas I like are like, equity markets still, I think, because they are not only nominal asset classes, they are also real asset classes in some ways. So I think obviously there will be sectoral implications of what we are discussing. And I think, and then we can go into the more details of that. So as I said, financials, defence stocks can benefit. then you have obviously, but you have to then navigate this with geopolitics, retaliation, risks, and at some point of it, which becomes more aggressive. So that's the navigation pathway. But it's gonna be more volatile. know volatility has been very low going into this election, which makes sense, right? People don't want to take a view.
The polls were suggesting a very close race. So you could see at the market level, realised vol has been coming down. So bond market volatility is back. I think that will remain the case because we're going to have a lot of expectation-based moves right now till the administration comes in and starts putting things into play, into motion.
I think that rate volatility affecting equity volatility has to be watched as well. So overall, we are still risk on, but with a different lens on it compared to a couple of months ago.
Lukasz
Well Salman, thank you very much for your insights, very timely and certainly great to of explore the various possible scenarios. But I think, you know, one of the interesting things is that markets seem to be continued chugging along. So we'll see what happens and all the best for the cricket as well. We'll see what happens there the next day or so. Thank you very much, Salman.
Salman Ahmed
Thank you very much. Thank you very much. At least please give us one game. Please.
Salman Ahmed
Thank you very much, Lucas.
