It’s hard to escape from headlines about the US presidential race, but so far, investors are taking this “unusual election season” in their stride, says Allianz’s Mohamed El-Erian. That’s partly because the split of power between Congress and the White House means that whoever is elected “would find their degrees of freedom quite limited – especially given some of the statements that have been made on the campaign trail”.
However, that could all change if there is “a clean sweep, with Democrats gaining control of both houses of Congress and of the White House”. On the other hand, a Donald Trump victory could cause disruption if he imposes “punishing trade tariffs on China and Mexico”.
All things being equal, El-Erian expects the Federal Reserve to raise interest rates three times over the next 15 months – once this year and twice more in 2017. The Fed’s hand will be forced by “continued robustness in the labour market, slowly rising inflation, and a widening recognition that persistently low rates increase the risk of financial instability down the road”. Indeed, El-Erian would have liked to have seen the Fed raise rates in September and reckons the US central bank “missed a window”, by not acting more aggressively last year.
That said, the potential for hikes will also be limited by structural headwinds to growth and economic weakness abroad. As a result, rates will peak at a level well below historical averages. El-Erian believes “stocks will be a lot more volatile than they have been so far this year” as “more improbables become reality and as central banks find it harder to repress financial volatility”. This “will also serve as a reminder of the extent to which traders and investors have underestimated the potential for bouts of unsettling market illiquidity”.