Weekly economic briefing: US mid-terms and the geopolitics of trade

The Weekly Economic Briefing is written by two senior Deloitte Economists, David Rumbens from Deloitte Access Economics in Australia and Ian Stewart Deloitte’s Chief Economist in the UK. They provide a personal view on topical financial and economic issues. Subscribe to receive the Weekly Economic Briefing in your inbox!

In this week’s blog: we focus on the US mid-term elections, and what the outcomes might mean for Australia. 

Australian economic briefing
UK economic briefing
International economic briefing

Australian economic briefing by David Rumbens

This section of the briefing provides a snapshot of key economic data and issues of relevance to Australia.

US mid-terms and the geopolitics of trade

As predicted by most of the polls, the Democrats regained control of the House of Representatives, while the Republicans increased their majority in the Senate (see Chart 1). Previously, the Republicans had full control of both the executive and legislative branches of government (the White House and both houses of Congress).

A divided Congress will likely make it difficult for major legislation to pass, as our global chief economist notes here. For example, the Republicans want to make last year’s tax cuts permanent, but this is now unlikely to happen. As for spending, there will probably be no significant shift in its trajectory, although it is possible that the two parties will agree to sustain the high spending levels that are currently set to decline in two years (and which would ease the drag on economic growth that this spending fall will otherwise create). On the other hand, the White House might find common ground with the new Democratic majority in the House on issues such as infrastructure investment and raising the federal minimum wage. Yet even on these, finding support in the Republican-led Senate would be difficult.

Chart 1: US congressional election results

Source: New York Times, as at 11am AEST

What does all this mean for Australia (and the world)?

We don’t expect the election results to cause the Trump Administration to step back from its current stance on trade, which is characterised by a scepticism about the current global system of relatively free trade, and a willingness to apply higher tariffs. If anything, the result may even increase the Administration’s attention on its trade agenda (which it can largely pursue without congressional support), if Congress frustrates its domestic policy agenda.

Closer to home, though, countries are pursuing more and freer trade among each other, without the US. This week, China is hosting an import expo in Shanghai. Chinese president Xi Jinping, in his keynote speech at the expo, has promised to reduce tariffs and boost China’s e-commerce and consumer spending, which has been welcomed by a number of Australian companies. With Sino–Australian tensions appearing to have improved lately, Australia’s trade minister, Simon Birmingham, is attending the expo, as are a number of Australian companies including ANZ, Australia Post, vitamin companies Blackmores and Swisse, food product companies Freedom Foods, Capilano Honey, Thomas Foods and Select Harvests, as well as Coles, Qantas, Telstra, and major miners BHP, Fortescue and Rio Tinto.

All this is a further sign that, while the US is pulling back from global trade, other countries are continuing to pursue it.

For more information on the Australian brief, please contact co-authors David Rumbens and Craig Michaels.

UK economic briefing by Ian Stewart

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to and view previous Monday Briefings at: http://blogs.deloitte.co.uk/mondaybriefing/

  • It ended on a high note last week, but overall October was a rotten month for equities. The world equity market has just had its worst month since 2012, with the benchmark MSCI world index down 7% in October. This fall has more than reversed earlier gains, leaving the global index down 3% so far this year.
  • October saw significant declines in most major equity markets, with falls of 9% in Japan and the euro area, 7% in the US and 5% in the UK and emerging markets.
  • The equity sell off and last week’s bounce reflect two conflicting readings of the global outlook.
  • The bears, or pessimists, think that rising US bond yields and slowing global growth mean the best is over for equities. Interest rate rises in the US, and an unwinding of quantitative easing, have pushed up yields, or interest rates, on US government bonds to a seven-year high. Higher yields affect equities in three ways. Improved returns on bonds makes equities less attractive by comparison. Higher yields also depress the current value of future dividend income. And in the long term higher rates and tighter monetary policy spell weaker growth and lower profits.
  • Bears concede these factors matter less when global growth is accelerating. But in emerging markets and the euro area the momentum of growth is slowing. US growth looks close to a peak. The risks to global growth are looming larger. The mood change was captured in last month’s Economist cover story, “The next recession, how bad will it be?”
  • Concerns over the effect of tighter US monetary policy and protectionism on the global economy, especially emerging markets, have raised fears about a harder landing for the global economy. Last month the International Monetary Fund cut its forecasts for growth in advanced and emerging economies.
  • The latest Fund Manager Survey by Bank of America Merrill Lynch reports that institutional fund managers are now more pessimistic about global growth than at any time since the depths of the financial crisis in November 2008. The survey also found that a record 85% of respondents think the global economy is in the late stage of the business cycle.
  • In a recent Financial Times article the economics commentator, Chris Dillow, analysed the history of equity markets’ ups and downs. His analysis of stock market data showed that good five-year periods in US and UK markets tend to be followed by bad periods – in much the same way that economic booms are followed by busts. If he’s right a 60% rise in the US S&P500 index in the last five years could presage a bumpier ride for investors.
  • The equity bulls draw exactly the opposite conclusion.
  • In the year to the third quarter profits for firms in the S&P500 rose a hefty 26%, the fastest rate in eight years. Despite stellar profits growth US equities fell in October, something which the bulls attribute to excessive gloom about the economic outlook. They observe that while growth in Europe and emerging markets has softened, the risk of a recession remains low and the US economy is going from strength to strength. The US market has seen bigger setbacks, in late 2015 and earlier this year on similarly excessive worries. These setbacks proved to be buying opportunities. And then there’s the fact that US wages are, at last, rising. That could prompt companies to go on an investment binge, lending a new impetus to productivity and to profits.
  • Bulls tend to see the recent action in the US equity market as reflecting a shift in investors’ preferences, not a flight from equities. On this interpretation investors are moving from fast-growing, but pricey, tech stocks paying low dividends to cheaper ‘value’ stocks that pay higher dividends and will gain from strong growth. So, for instance, Netflix, whose share price soared until September fell 17% last month while Proctor and Gamble, whose shares had drifted lower through the year, rose 7%.
  • For the bears the best is over. The bulls think that the recovery has more life left in it and that investors have become too pessimistic. As in all such debates only time will tell who is right.

P.S. There appears to have been a surge in Brexit optimism over the last week. Sterling had its strongest one-day rally since January last Thursday, rising to $1.30 following news that the UK Brexit secretary, Dominic Raab, expects a deal to be made on the Brexit withdrawal agreement by November 21st. The EU are striking a more cautious tone, with Michel Barnier, the EU’s chief Brexit negotiator, denying reports that an agreement has been made on post-Brexit financial services. UK bookmaker Paddy Power is pricing in a probability of two thirds that a deal is approved by the EU Council and UK Parliament before 29 March 2019.

OUR REVIEW OF LAST WEEK’S NEWS

The FTSE 100 ended the week up 2.2% at 7,094.

International economic briefing by Ian Stewart

Economics and business

  • The Euro area economy grew by just 0.2% in the third quarter, its slowest pace since 2014
  • Euro area inflation accelerated to 2.2% in October, its highest level since 2012, driven by rising energy prices
  • UK consumer borrowing growth fell to 7.7% year-on-year in September, its lowest level since June 2015 as borrowing for car finance fell sharply
  • The Bank of England kept interest rates unchanged but signalled it would increase the pace of rate rises if the UK negotiates a smooth Brexit transition
  • UK manufacturing activity grew at its slowest pace in more than two years in October, according to PMI data
  • US wage growth rose to 3.1% year-on-year in October, its highest level in nearly a decade
  • Japan’s unemployment rate fell to 2.3% in September. A tight labour market has led the government to consider easing visa requirements for migrant workers
  • Far right candidate Jair Bolsonaro won Brazil’s presidential election, sending the country’s stock market to a new all-time high

Brexit and European politics

  • German Chancellor and leader of the Christian Democratic Union party, Angela Merkel, said that she will stand down as party leader in December, a position she has held for 18 years
  • The FT reports that the EU has proposed a new Irish backstop under which Northern Ireland would be fully aligned with the EU’s customs and single market, while the UK would be in a “bare-bones” customs arrangement and only apply the common external tariff to non-EU imports
  • The Times reported that a financial services deal had been agreed which enabled UK companies to continue access to EU markets after Brexit, provided that both the UK and EU maintain equivalence in financial regulation
  • UK-EU cooperation on cyber security will continue at the same level after Brexit, according to the head of the UK National Cyber Security Centre
  • Italian prime minister Giuseppe Conte said he was confident that Italy could come to an agreement with the EU on its fiscal expansion plans
  • Brexit Secretary, Dominic Raab, confirmed that there is “no set date for [Brexit] negotiations to conclude” after it was leaked that he expects a deal to be finalised by 21 November
  • Robert Chote, the chairman of the OBR, the UK’s budgetary watchdog, said that a Brexit deal was “unlikely” to hugely improve UK public finances
  • The credit rating agency, Standard and Poor’s, said a no-deal disorderly Brexit would lead to “5.5% less growth by 2021” than an orderly exit with a transition period

And finally…

  • The Metropolitan police is to start selling merchandise and clothing bearing its logo. It takes its lead from the New York City Police Department (NYPD) which licensed its name back in 2001. The proceeds from the sales of clothes and other goods will raise money for the force – fashion police

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