I’ve spent a fair bit of the week getting battered about on Cornish beaches by some (by my standards) big waves whilst trying to act as lifeguard for our three kids whose enthusiasm for surfing outweighs, for now, their abilities
Back in the world of finance, bond markets have also been battered once again as investors try and find a price level that balances the prospects for rates staying higher for longer, diverging economic prospects and the unknowns around geopolitical risks that could have consequences for both growth and inflation.
The diverging economic prospects were highlighted by the flash PMI data, which continued to point to economic contractions on this side of the Atlantic, but suggested the US economy was still seeing economic growth. In the US, both manufacturing and services PMI data improved in October relative to September and were above the level that separates expansion from contraction. For the eurozone, the equivalent PMI data fell further into ‘contraction’ in September and was weaker than expected. The UK data was somewhere in between – still in ‘contraction’ but not quite as weak as had been expected. The PMI numbers suggest that economies are moving at differing speeds, with rate hikes having more of an impact in the UK and eurozone than we have seen so far in the US, where the economy still appears on a sound footing.
We should remember that the US has seen the benefit of a huge amount of fiscal spending this year, part of an attempt by President Biden to boost his ratings and push recession risks out to beyond the elections next year. Biden’s approval ratings suggest this policy has not worked, but the economic data shows the US economy is still ticking along well. Q3 GDP data published this week showed the US economy to be growing at an annualised pace of 4.9% during the quarter, a stronger level than expected and driven predominately by consumer spending and up from an annualised rate of 2.1% in Q2. Can the US economy really be accelerating or is this a last hurrah for consumer and government spending before interest rates and fiscal reality begin to bite? We think the latter. We haven’t seen the equivalent data for the UK and eurozone yet, but the numbers (even though the data is not annualised as we see in the US) are expected to be somewhere between -0.1% and 0.4% at best, highlighting that the UK and Europe are stagnating, even without the full impact of rate hikes feeding through.
Data from the European Central Bank’s (ECB) lending survey also missed expectations, suggesting that supply of, and demand for, credit has shrunk as interest rates have risen. Good news, in the sense that monetary policy is having the desired effect. ECB President Christine Lagarde told the European Parliament the fight against inflation was “tracking well” but noted she expected the eurozone economy to stagnate over the coming quarters even as inflationary risks became more balanced.
As expected, the ECB chose to keep interest rates on hold at 4% at their meeting yesterday as they look to balance concerns over persistent inflation against increasing fears over the economic outlook. Christine Lagarde said that growth was “likely to remain weak over the remainder of the year” with the impact of higher interest rates “broadening”. Eurozone inflation has eased from a peak of 10.6% a year ago to 4.3% last month; next week the data for November is expected to show inflation closer to 3%. But Lagarde said inflation was expected to be “too high for too long” with the ECB statement noting that “rates will be set at sufficiently restrictive levels for as long as necessary”. Given the continued easing in inflation, combined with lacklustre economic growth expectations, it would be a huge surprise if the ECB were to raise interest rates again from here, though Lagarde said it was “totally premature” to discuss when interest rates would be cut, though markets are pricing two cuts by the end of next year.
Further afield we saw a policy shift in China, where President Xi announced fiscal support to the tune of $137 billion, funded through additional sovereign debt being issued. The fiscal deficit as a result was raised from 3% of GDP to 3.8%. Changing the deficit target from the 3% target, set in March, is an unusual step but suggests a recognition that more policy moves are required to achieve the 5% growth target this year. Further policy moves will not come as a surprise as the Chinese authorities attempt to bolster an economy that still appears to be suffering from a COVID hangover.
Somewhere there hasn’t been much policymaking happening of late is the US, where the House has been without a Speaker for the past three weeks following the removal of Kevin McCarthy by a small number of conservative Republicans (and with the aid of the Democrats who were all too happy to see Republican infighting). We have seen three candidates come and go and pressure was starting to build given that without a Speaker, per the Constitution, the House cannot pass any legislation. Republicans have aligned behind Rep. Mike Johnson of Louisiana, described by the Financial Times as a ‘staunch conservative’. Johnson was backed by Donald Trump and is said to be in favour of a spending deal, so this should improve the prospects for the US to avoid a government shutdown when the current temporary deal ends in the middle of next month.
Have a good weekend,
Regards,
Anthony.
