A buoyant U.S. economy continues to contrast with indifferent Chinese data, while structural problems persist in Europe. Do our base-case scenarios suggest any possible reversal of this pattern?
1. U.S. mid-term elections will not change economic policy direction, but any equities rally could be muted.
The U.S. holds its midterm elections on November 6 and current polling and prediction markets are suggesting that they could result in a “split” government, with the Democrats likely to win the House of Representatives but unlikely to win the Senate (page 2). This scenario would be unlikely to prejudice U.S. growth as tax cuts could not be reversed in this situation and, if anything, fiscal spending might actually move higher. Continued strong economic growth and a progression of the tightening cycle by the Fed is still expected to push global sovereign rates higher 12 months and although history suggests that equity markets usually make gains in the 12-month period after the election, the rally this time may be relatively muted. But, even so, the U.S. economy and markets should remain generally positive.
2. We still expect a Chinese soft economic landing, despite slower export growth, but continued market volatility looks likely.
By contrast, as we discuss on page 5, Chinese economic data over the next few months could be mixed. Export growth was higher than expected, but this may have been due to firms front-loading shipments and the new orders PMI has fallen to its lowest level in two years. Weaker export growth could be a drag on Chinese GDP growth in Q4, but our central scenario remains an economic soft, rather than hard, landing. Government stimulus could play an increasing role in supporting growth in Q4 amidst a weakening export sector and higher issuance of local government bonds in recent months suggests that infrastructure investment is likely to pick up soon. But even if, as seems likely, the economic slowdown is well managed, this will not stop continued volatility in the Chinese equity and bond markets in coming months. On pages 6 and 7 we discuss what factors could help boost these markets.
3. The Brexit impasse should eventually prove resolvable, but the path to it will be bumpy and unsettling for markets.
In Europe, the two main structural problems remain Brexit and Italy. This week’s EU leaders’ Brexit summit failed to achieve a breakthrough, but did hint that the transition period could be extended (page 3). Our expectation remains that a deal can be reached with the EU, and then ratified by the UK government, but the path to this could be bumpy and a hard Brexit remains a possibility. The markets’ focus will return to Italy when the EU Commission expresses its views on the budget, and rating agency decisions draw closer. We continue to think that the Italian government could prove more reactive to markets than to EU institutions.
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