It has been a reasonably tough week in markets with both equities and bonds struggling for momentum
While it may be good news that the economic backdrop is solid, it is once again causing markets to reassess the size and speed of interest rate cuts in the US. In the UK and eurozone the direction of travel for rates appears more obvious, with inflation below target and growth relatively subdued. But in the US the economic backdrop is stronger, and combined with markets once again shifting to price in a Donald Trump election win, the view that a US economy driven by lower taxes, (even) higher government spending, and significant increases in tariffs suggests interest rates may be higher for longer. Markets are now only pricing 42 basis points of rate cuts in the US before the end of the year.
There is a notable gap opening up in the US between the opinion polls, which still give Kamala Harris a very slight lead at the national level over Donald Trump, and prediction markets based on bets placed, which have in recent weeks resoundingly shifted towards Donald Trump. Harris’s lead in the national polls is not matched in the swing states, most of which are too close to call. It would not be a surprise to see Harris win the popular vote but lose the election thanks to the mathematics of the electoral college. Much like the last election, this will come down to a few hundred thousand votes across seven states. There has also been more chatter over a contested election and it seems likely that November 6th – the day after the election – may not bring complete clarity over the outcome. Bloomberg research has identified 165 lawsuits across 37 states already underway ahead of the US election. Over half of the cases are in the seven ‘swing states’. Republicans have been slightly more active than Democrats, filing 55% of cases. Republicans have focussed on narrowing the electorate, pushing to remove names from lists of registered voters. Democrat challenges are more around what they argue are illegal barriers to voting. Expect plenty of recounts and legal challenges – a period of uncertainty that will likely not be received well in financial markets.
The IMF and World Bank meetings have been taking place in Washington DC this week, and as usual, the IMF have updated their world economic outlook. They modestly downgraded their global growth forecast for 2025 their previous update in July. They expect growth next year to be a “stable but underwhelming” 3.2% (vs 3.3% previously). The US was upgraded to 2.22%; this offset downgrades in Europe, with German growth expectations downgraded to 0.8%. The IMF said risks remain tilted to the downside with eruptions in financial market volatility, as seen in August, potentially impacting financial conditions and weighting on investment and growth. The IMF also warned of “continued mediocre medium-term prospects relative to pre-pandemic forecasts”, estimating global growth in five years’ time to still be around the 3.1% level. IMF Chief Economist Pierre Oliver Gourinchas noted that the global battle with inflation has “largely been won”. Having peaked at 9.4% in late 2022, the IMF projects inflation to fall to 3.5% by the end of next year, a level which is slightly below the average of the two decades that preceded the pandemic. Gourinchas highlighted the resilience of the global economy through the disinflationary process of the past 18 months, noting that the decline in inflation without a recession is a major achievement. While much of the decline in inflation can be attributed to the unwinding of the shocks that first caused it, Gourinchas notes the crucial role of monetary policy in keeping inflation expectations anchored and avoiding disastrous wage-price spirals and the experiences of the 1970s.
In a reference to the policies of the candidates in the upcoming US presidential election, the IMF warned that an intensification of protectionist policies would exacerbate trade tensions, reduce market efficiency and further disrupt supply chains. They estimate that if higher tariffs impact a “sizeable swath” of world trade by the middle of 2025, it would take 0.8 per cent from output next year and 1.3 per cent in 2026. IMF Chief Economist Gourinchas said “it’s a policy that is basically harming everyone”. Kamala Harris has backed higher tariffs on some Chinese goods; Donald Trump has called for a 20 percent tariff on all US imports and a 60 per cent penalty on all Chinese goods. Gourinchas warned that the IMF’s assessment of the impact of tariffs could be “compounded” by further retaliation. Gourinchas also warned on the fiscal outlook, not least in the US and China where current fiscal plans will not stabilise debt levels. A delay to fiscal consolidation “increases the risk of a disorderly market-imposed adjustment” but equally an excessively abrupt shift to fiscal tightening could be self-defeating and impact economic activity.
There was better news in the IMF outlook for the UK, with growth accelerating as falling inflation and interest rates boost domestic demand. The IMF expect the UK economy to grow by 1.1% in 2024, up from 0.7% in their previous forecast. Growth is expected to pick up to 1.5% in 2025. IMF Chief Economist Gourinchas told the FT that the improving inflation backdrop may allow the Bank of England to accelerate the pace of interest rate cuts. The IMF’s projection for 2025 growth is below that of the UK’s Office for Budget Responsibility, though we will see updated figures from the OBR in the Budget next week. The UK government has continued to test the waters with policies being floated ahead of the Budget next Wednesday. Chancellor Rachel Reeves confirmed the government will change the way it measures debt in order to fund extra investment. The government will in future target PSNFL – Public Sector Net Financial Liabilities – which is actually the IMF’s preferred measure of debt. Such as shift in the rules could free up around £70 billion more than available under the old rules. Writing in the Financial Times, the Chancellor emphasised the difference between this spending and ‘everyday spending’ that will be matched by tax revenues. Gilts have underperformed in recent days, reflecting some tension in markets over the new government’s fiscal plans. The government, desperate to avoid a ‘Liz Truss’ moment in markets, appears to have made a concerted effort to pre-announce some of the biggest policy shifts, though there remains a lot of uncertainty around the details around taxation.
Note there will be no update next Friday. With my usual impeccable timing I will be on a Cornish beach for what is likely to be a very important UK Budget, but I will return in time for the arguably even more important US election the following week.
Source: Bloomberg as at 25-Oct-24
