Monday Digest
Posted 16 September 2024
Market fears fading
Global stocks recovered well last week, in a sign that the early September jitters are fading, just as the August ones did. Not because the European Central Bank (ECB) cut interest rates again – given president Lagarde warned that the path down isn’t guaranteed. This was interpreted as a hawkish signal, and markets’ implied European rate expectations flattened somewhat. The decision came just after a former advisory board member argued in the FT that the “ECB has no room to cut rates”. They pointed to sticky services inflation, and Eurozone rates being two percentage points below the US. But Europe’s economy clearly needs support, as highlighted by former ECB president Mario Draghi’s call for a “new industrial strategy”.
By contrast, the US Federal Reserve’s clear dovishness is supporting US markets. Stocks were boosted by inflation data, which showed domestic demand staying strong. This probably would have unnerved markets a few months ago – suggesting persistent inflation and possibly delayed rate cuts – but investors are now happy about US resilience. This was matched by a general sense of fears dissipating, including a rebound for Nvidia. The US presidential debate didn’t move markets in either direction, but that too is a sign that investors are confident enough about the economy.
So, attention turns to the Fed’s meeting this week, with the bank expected to deliver at least a 25 basis point cut. A bigger cut might be interpreted negatively, as the Fed lacking confidence in the US economy. Ultimately, the trajectory and pace of rate changes matter more than the magnitude of individual cuts – and the Fed has been clear it wants to be supportive. This stance perplexes some, considering US economic strength and, hence, relatively smaller need for policy support. But, inflation and employment are more delicate than they seem, and there are pockets of the economy which are struggling from high rates (as shown in problems at Ally Financial).
We therefore expect the Fed to cut, even possibly by 50 bps in a repeat of their successful past shock and awe approach. There could be volatility if officials do opt for a 50 bps cut.
Budget and growth gloom make UK rate cut certain
Chancellor Rachel Reeves has warned of “difficult decisions on tax, on spending, and on welfare,” at the 30 October budget. Investors are worried this might mean changes to capital gains tax (CGT) or pension relief. We have said for months that CGT will probably rise, but shouldn’t affect the value of UK investments too much. Pension changes could be more significant, as these have more direct economic impacts.
Unfortunately, recent UK data matches the government’s gloom. Growth was flat in July and manufacturers are struggling – despite apparently positive sentiment surveys over the summer. Annual inflation was below expectations, and prices fell month-on-month. Unemployment fell, but youth unemployment rose to its highest since the pandemic. Britain seems to be in a similar phase to the decade after the global financial crisis: low unemployment and low inflation – but sluggish growth.
Markets therefore expect the Bank of England to cut rates by 25 basis points in November. BoE hawks warned about a ‘wage-price spiral’ as recently as August, but payroll data is weaker than in the US – where the central bank is now worried about a deteriorating labour market. The hawks will likely back down, and the BoE could cut rates by more if the Labour government enacts the austerity it alludes to.
Previously strong business sentiment – particularly among housebuilders – might have been pumped up by the new government’s honeymoon period. Now that it’s over, we’re seeing weaker data, but much of it is backwards looking. The steeper path for rate cuts into 2025 should help, supporting mortgage owners. It is too early to tell whether the green shoots of a few months ago will bear fruit, but recent signs are less than ideal. The outlook is not all dreary, but summer chirping is certainly over.
How China trades
Chinese exports were surprisingly strong in August. This suggests Chinese producers are rushing out inventory, ahead of a potential second term for Donald Trump, and the increased tariffs that would bring. US-China trade has been hampered since Trump first came in, and last year Mexico officially replaced China as the US’ largest trading partner.
Often underappreciated is the fact that the US is not China’s biggest trading bloc either, though. EU-China trade was worth more in 2023, and ASEAN (comprised of 10 southeast Asian nations) is China’s largest trading partner by far. This is in part fallout from the US trade wars, but it could dampen the impact of any new tariffs. If so, Beijing has to think about its trade policies differently. It kept its currency stable against the dollar for most of 2024, for example, despite domestic weakness. That effectively meant tighter Chinese financial conditions and less competitive exports.
Total trade isn’t the whole story, though. The US accounts for China’s largest trade surplus (meaning capital flows from the US to China) and Washington’s tariffs tend to influence other tariff regimes around the world (the EU has since introduced a levy on Chinese electric cars, for example). If Trump entered the White House again, he could also do indirect damage to China by putting tariffs on other countries. Much of China’s exports to ASEAN, India and Mexico are intermediate goods which are re-exported to the US, for example.
China wants to shift its economy to become domestic demand led like the US, but this process has stalled in the last few years and consumption is weak. A weak export outlook is another hurdle, and Chinese exporters seem resigned to a gradually worsening tariff environment. We expect Beijing to maintain a diplomatic dialogue, but impose occasional countermeasures as they pursue a long-term trade realignment.