Monday Digest

Posted 4 November 2024

US, not UK, battening down the hatches

The budget dominated headlines, but global investors were again preoccupied with US politics. We said that volatility could spike amid tense markers, and that’s exactly what happened. It could continue until the US election outcome is eventually clear.

Many framed the UK budget as a fundamental change, but ironically the main economic impacts look cyclical rather than structural (according to the OBR). Rachel Reeves painted the budget as a starting point – the medicine before later supply-side reforms. We hope so, but only time will tell. Markets reacted negatively but not horribly: stocks fell and government bond yields rose. At least some of the yield rise was budget-related, but for now debt costs still look manageable.

UK bond yields also reacted to higher US bond yields, which rose because of Trump’s possible tax cuts and fiscal deterioration. Bond traders are getting nervous ahead of election day. We suspect non-US investors are also worried about political stability – judging by the fact higher US yields have not attracted the usual level of demand. Stocks sold off on Thursday, as a reaction to bond moves and underwhelming corporate earnings, but, this says more about short-term investor positioning than overall sentiment. We already know that US growth is improving from a slow summer. Absent a damaging post-election fight, the US is well positioned.

European earnings are worse – and unlike the US, it is not just past earnings but future expectations. Russia’s gains in Ukraine weigh heavily, and what happens there depends on the US election too. On the other hand, Middle East tensions have simmered, after Israel’s relatively tame response (avoiding oil sites) to Iran’s missile barrage. Oil prices fell, which should be a boon for global growth. But again, for positivity to manifest, we need to get the election over with.

October asset returns review

Global stocks gained a respectable 2% last month in sterling terms, but this was almost entirely down to US markets. Large US stocks rose 3.4% in sterling terms, partly due to an improved economic outlook and partly due to dollar strength. Economic data releases made it clear that the US summer soft patch was just a blip and investors are broadly confident about the future – but volatility spiked at the very end of October. This was mostly about investors rolling back risks ahead of the deeply uncertain presidential election. Bond yields rose on a combination of stronger expected growth, the possibility of Trump’s tax cuts and ensuing fiscal deterioration.

Some might see higher yields as a ‘risk off’ sign, alongside the stronger dollar and record high gold prices, in light of Middle Eastern conflict. But Israel-Iran risks actually dissipated through the month, lowering oil prices.

European stocks fell 1.9%, amid a worsening growth outlook. Falling interest rates will help, but European companies face a tough road ahead. UK stocks also finished down, while bond yields went up – but this was less autumn budget related than media commentary would suggest. The yield bump at the end of October was partly due to the budget, but month’s trend was more about higher US yields. Japan’s initial stock market struggles, meanwhile, were about political uncertainty – but stocks actually gained in the end after a snap election surprisingly lost the government its majority.

Last but not least, Chinese stocks bounced up and down depending on how strongly investors approved of Beijing’s economic stimulus announcements. Policymakers announced $1.4 trillion worth of extra debt issuance last week, but on closer inspection this was more a restructuring (moving local government debt to the central government) than new fiscal support. Beijing’s stimulus drive has helped – reflected in China’s outperformance over three months – but we still don’t know by how much.

Demographics and economics

The ONS reported last week that fertility rates in England and Wales fell to the lowest point on record in 2023. Demographic shifts are never linear, so the birthrate is likely to increase again in the next decade (it looks like we’re at a trough), but the long-term trend is clearly down. People often worry that this could lead to a shrinking, aging population.

The basic problem with that is it leads to more people depending on economic production than those able to produce, holding back growth. If the economy and worker base isn’t expanding, businesses can’t grow and investment declines, ultimately affecting living standards. This is what happened in Japan’s so-called ‘lost decades’: its population now is the same as in the early 1990s, during which time it has gone from the second-biggest economy in the world to the fourth.

But Britain’s population is actually growing, thanks to immigration. Experts think that, because of declining fertility, the UK will need continued net immigration to sustain a working age population for the rest of this century.In situations like these, immigration becomes one of the driving forces of an economy. US immigration, for example, surged post-pandemic which many have argued boosted growth and solved a shortage of labour supply – bringing down inflation.

Of course, that immigration surge has resulted in Donald Trump promising to deport millions. It’s easy for economists to think of this as an aggregate supply-demand problem, but distributional effects matter, both economically and for social cohesion. Moreover, on a global scale immigration is by definition zero sum. What will happen to the global economy when the world population stops growing? Optimists suggest technology and automation could be the answer – but that’s often just as socially difficult as immigration. Thankfully, we have a while to work out the answer.