The Federal Reserve chose not to raise rates in September, despite speculation by many participants that they would. The decision went as we expected since the Fed is generally unwilling to move rates this close to a presidential election. As an institution, the Fed is very reluctant to take actions that could be interpreted as favoring one or another party. Absent a genuine crisis (as in 2008), Fed governors will heavily favor inaction in a presidential election year. Inaction in this instance means an expansionary monetary policy with very low rates, and this does indeed benefit the incumbent party. In our view, this is more accidental than deliberate.

For a number of decades, central bankers have walked a fine line. They are political appointees, but their decisions are supposed to be apolitical, and they enjoy a degree of independence not afforded to the heads of other government agencies. Like all senior government officials, Fed governors are politically attuned and they undoubtedly have personal political preferences. In a normal election year, with a more typical slate of candidates, Fed inaction might lead to quiet grumblings within DC circles. But this is not a normal election year.

We have seen Mr. Trump repeatedly attack the Federal Reserve chair, Janet Yellen, in very personal terms for keeping rates low. This has received very little attention among all the other political news and outrageous statements by Mr. Trump in this cycle. As with so many things this year, we cannot say whether or not berating Fed officials will become the political norm.

What we do know is that in most countries, the slightest hint of overt political “interference” in central banking decisions can spook markets. The enormous volatility of the South African Rand over the past year is a case in point. European markets saw similar gyrations during the months leading up to Mario Draghi’s succession of Jean-Claude Trichet.

Though berating the Fed is a small part of Mr. Trump’s political plank, we had to go back to Williams Jennings Bryant’s candidacies of 1896 or 1900 to find an instance where central bankers and monetary policy was dragged into an American political contest in such a way. And that was back when US dollars were backed by gold in a fixed amount. Neither the Nixon administration’s abrogation of the gold standard nor Mr. Volcker’s unremitting steps to control inflation elicited such personal invective. As long as Mr. Trump’s chances of winning the presidency remain slim, the market will remain sanguine. If the prospect of a Trump presidency were to become more likely, we expect the future monetary policy of the US to become an area of immense concern for the markets.

We have discussed interest rates extensively in our previous letters, and would like to briefly turn our attention to debt levels. Extremely high levels of debt were the primary cause of the 2006-2009 financial crisis and generally make for a riskier financial system. Though US households and enterprises continue to reduce debt (deleverage), global debt levels have continued to rise. Looking at World Bank and IMF data, we can see that global private sector credit now exceeds 2008 levels (measured as a percentage of GDP). US private sector debt, at almost two times GDP, remains higher than the global average. Much of the growth in global debt levels has come from China where debt to GDP levels have risen significantly. In 2008, the World Bank pegged Chinese domestic credit at 100% of GDP. By 2015, this had risen to 150%.

Chinese debt has not yet reached extreme levels, but the rate of growth is more extreme than it was in the US between 1994 (when debt was 120% of GDP) and 2008 (when it reached a peak of 206%). Economies linked to China in the Asia-Pacific region (Australia in particular) have seen increases of similar magnitude. Latin America and the Middle East round out the regions where debt loads have increased, but levels remain relatively low, around 60-70% of GDP. China remains the biggest risk, since it has a relatively immature credit market which has seen enormous growth in the past decade.

In the US, equities markets have remained in a tight range for the past three years as consumers chose to reduce debt and forgo spending. The S&P 500 has continued trading between 1800 and 2200 since 2014. This can also be partly attributed to the tail end of the business cycle, with no immediate catalyst for either further growth or a retraction. At this stage, we would expect inflationary concerns to force interest rate hikes, but inflation is low to non-existent as consumers continue to reduce leverage and remain price-conscious. For the Fed, this remains a challenging period, with few answers available in textbooks. That said, we expect the Fed will raise interest rates in December, after the election is safely settled, likely by 0.25%.

Investors face similar uncertainties and we continue to advocate for cautious asset allocation and a focus on defensive companies and sectors.