Latest US data worries investors and global politics take yet another turn
A soft Institute for Supply Management (ISM) Manufacturing report led to increased worries related to the global economy in the past week coming on the back of disappointing Purchasing Managers’ Index (PMI) data from the Eurozone the week before. However, in the US itself, it is possible to view this data in the context of a downturn in global manufacturing, and despite a weaker ISM services report too, domestic consumption remains strong and housing investment is picking up in response to easier financial conditions, we think recession fears remain some way off. Indeed, this week’s ISM manufacturing data is consistent with 1.5% GDP growth and numbers below 42 on this index would typically be needed to be seen before this would suggest a negative quarterly GDP number.
Nevertheless, with the political environment in the US also continuing to sour and little good news to cheer, it isn’t too surprising to see stocks trading lower and a flight to quality keeping bond yields low. Following meetings with policy makers in Washington this week, it seems as if opinion is split as to whether the Fed will cut again at the end of the month. However, lower equity prices and a firm dollar may be tipping the scales in favour of further action in the absence of any new, more constructive news. With respect to trade, a deal with China remains remote, though a ceasefire with some deferral of tariffs is possible with Trump concerned that the economic outlook cannot deteriorate if he is to win election next year.
Several months ago, it appeared that the election could be Trump’s to lose but there is a sense that this is much more of a 50/50 call, with Warren seen as the leading Democrat contender. A Warren Presidency could be even more hawkish on China with talk of sanctions at a Justice Department level a distinct possibility, for example, if events in Hong Kong continue to worsen.
More broadly the narrative seems to be one of disengagement with China at multiple levels with Beijing viewed universally as a Strategic Adversary. Aside from China we would see a Warren Administration as one which would raise wealth taxes, expand free healthcare and look to clamp down on drug companies. A Warren win is viewed as a possible negative for stocks ((with projections quoted in the 15-25% range) and this could be an additional factor which could cap gains in the S&P in the months ahead.
Brexit continues to be the dominant topic driving markets in the UK and is an increasing focus in the Eurozone as the October 31 deadline approaches. We are sceptical that Johnson’s initial plan for a deal will find sufficient support (particularly from the EU) and so wait to see when Parliament will act to apply for an extension by removing Boris from power when it becomes clear that he will not respect their intentions. Ultimately this has become a political game with respect to who emerges strongest going into a General Election campaign and we see next to zero chance that the UK leaves with No Deal and no preparation, in a few weeks from now.
Looking ahead, today’s Payroll data may be key in influencing the Fed’s thinking as they approach their next FOMC meeting at the end of October. If jobs growth can remain robust, this may reassure markets on the growth outlook and could cause Powell to defer further easing until the December meeting. However, any suggestion that the slowdown in manufacturing and business investment is causing hiring to slow and businesses to shed jobs could be a clear catalyst for additional action on the monetary policy front. For now, we choose not to take an active directional view on the US in a climate of some uncertainty but longer term, we remain upbeat on US growth prospects and this leaves us biased to look for rates to rise at a later point, as well as retaining a constructive US dollar view.
Labour market data will also be important to watch in Europe as well. So far, there has been no sign of falling employment even as growth slows towards a standstill in countries like Germany. However, this may change if the outlook fails to improve relatively soon. This could increase pressure to deliver a more expansionary fiscal policy more quickly. With the Green Party in Germany continuing to grow in support (as is the case with many Green Parties across the continent), we sense that the next Chancellor after Merkel will be a Green Chancellor. Such an outcome could lead to more rapid fiscal progress in conjunction with Macron who appears very likely to win a second term at this stage.
Given our UK views see a General Election, which could well deliver a Labour coalition government by the end of the year, it is possible to think of a global landscape populated by Corbyn (or McDonnell) in the UK, a Socialist orientated Green Party in Germany and Warren in the White House in a couple of years from now. In such a scenario, the global political landscape will have seen a meaningful shift to the Left and having worried about the possible rise of right-wing populists for the past few years- it may be that we are starting to see a more profound political turn in the opposite direction. With ultra low bond yields offering a once in a generational opportunity to boost government spending without worrying about debt levels and borrowing costs - it could be that this shift occurs at a very fortuitous moment. It may still be some way off, but it is possible to see how and why the rally in bond yields will meet its end and that fact that this could happen soonest in the UK continues to suggest to us that a short stance in Gilts versus other assets is the best way to represent this view.