Financial Update from Brewin Dolphin - 19 July 2024

July 2024

The Weekly Round-up

Friday 19 July 2024

In our latest weekly round-up, Guy Foster, Chief Strategist, analyses developments in the U.S. presidential election, the performance of the semiconductor industry, UK inflation data and the likelihood of interest rate cuts.

Markets had a lot to digest this week, which began with the high drama of an assassination attempt on former U.S. President Donald Trump. The details of the shooting have been well-covered elsewhere, but the impact on markets and the economy was determined by the boost it gave to former President Trump’s already soaring odds of victory.

Later in the week, Trump accepted the Republican nomination and named 39-year-old Ohio Senator J. D. Vance as his running mate. Trump’s miraculous escape, and a charismatic and articulate performance by the new potential vice president, marked a very successful week for the campaign.

The travails of President Joe Biden have also been helpful. Over the course of this week, his chances of victory have been downplayed by the giants of the Democratic Party including, according to the Washington Post, former President Barack Obama. The Democrats’ top-ranking senator was reported as having urged Biden to step down. A statement issued by his office didn’t deny the report. Former Speaker of the House of Representatives Nancy Pelosi reportedly told House Democrats she believes he can be urged to exit the race.

To cap the week, Biden contracted Covid and is now self-isolating. Betting and prediction markets see his chances of running successfully considerably diminished, with current Vice President Kamala Harris now the most likely candidate to take on former President Trump. President Biden has not pulled out yet, but expectations are mounting for him to do so.

Political analysis site 538’s polling tracker shows Trump has increased his polling lead by three percentage points. This suggests the race for the White House remains competitive. In head-to-head polling, Harris performs about the same as Biden against Trump.

Although I have long suspected that Trump would win this campaign and recent events have been favourable for him, the objective evidence is that Trump’s now leading in what’s still a surprisingly tight race. The Democrats changing candidates (assuming they do) will see them lose the advantage of incumbency but offers an opportunity to reset their campaign.

How has this impacted markets?

In terms of the market impact of these events, the increased possibility of Trump winning was accompanied by a steepening of the yield curve. He’s assumed to have plans to raise debt and generate inflation, which means longer-term interest rates should be higher. This comes alongside evidence from last week that the Federal Reserve (the “Fed”) would be in a better place to cut interest rates having now seen two months in which so-called “supercore” inflation (services consumer price index excluding housing costs) was negative.

That measure had been running frustratingly throughout 2024, but May and now June have given negative readings, which will be massively reassuring to the Fed. Potentially lower short-term interest rates and potentially higher longer-term interest rates mean the curve has started to steepen, or at least become less inverted.

In an interview with Bloomberg released earlier this week, Trump made some important remarks. On the positive side, he seemed to indicate he would allow Fed Chairman Jay Powell to complete his term. Although he added the caveat, “especially if I thought he was doing the right thing.”

Trump signals clearly that he won’t allow the central bank as much independence as more conventional candidates would. That said, he isn’t indicating there should be a change in policy.

Developments in chipmaking

Markets experienced a stumble this week and Trump’s words may well have had something to do with it. After a period in which stocks have performed well (mainly driven by large-caps such as technology and communications services, with a specific focus on semiconductors), we have begun to see a reversal of some of these trends.

Firstly, small-caps began outperforming, then a sharp sell-off began in the semiconductor names. In the previously mentioned Bloomberg interview, Trump refused to commit to protecting Taiwan from potential Chinese aggression. Indeed, he accused the island state of having “stolen” America’s chips industry.

America’s support for Taiwan is important, most obviously in terms of being prepared to provide direct naval support, as Biden has promised. However, assuming Taiwan retains its territorial defences, the challenges of an amphibious assault would seem to be almost insurmountable.

If Trump’s comments did lead to conflict in Taiwan and that led to disruption to the Taiwan Semiconductor Manufacturing Company’s (TSMC) production, the implications for the sector would be harsh, with shortages downstream and a big reduction in demand upstream.

However, if Trump’s preference is reducing reliance on foreign-manufactured semiconductors, that implies a big increase in demand for semiconductor manufacturing equipment makers.

During Trump’s tenure, TSMC committed to building plants in Arizona. But its appetite may be waning as construction difficulties and a chipmaking skills shortage have slowed construction and dimmed the outlook for output. Trump may be calculating that a little jeopardy would keep TSMC focused on expanding its U.S. operations.

One such company would be ASML, which also fell as the market reacted to Trump’s comments. However, it would be wrong to suggest that Trump was the only factor weighing on the stocks. The Biden administration is reportedly considering more severe curbs on the use of U.S. technology within Chinese chip manufacturing processes. This is a threat designed to encourage companies like ASML to limit their business with China.

The news came in a week when earnings from companies within the chipmaking value chain have seemed quite robust. ASML, which makes chip manufacturing equipment, and TSMC, which uses that equipment, both reported strong orders.

Will the Bank of England cut interest rates?

Back in the UK, we had a succession of data to welcome in the new government.

As speculated in previously weekly round-ups, the welcome declines in the consumer price index (CPI) were most impressive in the last report ahead of the election. In June, CPI failed to drop below the 2% target, as had been the consensus forecast. Instead, headline inflation remained at 2% while core inflation accelerated slightly. This was considered bad news for the Bank of England’s Monetary Policy Committee (MPC), which might discourage it from cutting interest rates.

However, we noted the decline in median CPI, which seems a more stable estimate of underlying price pressures. It suggests that eventually, like in the U.S., underlying inflation will ease in the UK.

If, on the surface of it, CPI data might prompt the Bank of England to delay cutting rates, subsequent wage growth rates were stable enough to rekindle its appetite. Furthermore, this morning’s retail sales were weak and will provide another modicum of encouragement for the MPC, which seems eager to reduce interest rates if the move can be supported by recent data.

I would have thought that, in totality, this week’s data should provide the ammunition it needs, although the market believes it’s a coinflip whether rates get cut or not.

Over and outage…

Lower interest rates would be encouraging for the markets. However, the week ended in a downbeat mood. Following the semiconductor sell-off, there was a global technology outage today due to a flawed cybersecurity software update by CrowdStrike. This impacted Microsoft and had ongoing implications for many other users.

Most striking was the impact on air travel, which itself suffers from cascading effects when parts of the schedule are disrupted. With both airlines and airports affected, the impact was significant. However, a botched update is a less concerning cause than a malicious cyberattack and should not on its own cause lasting market angst.