And we’re back.
And we’re back
The US government finally reopened after 43 days – the longest ever government shutdown beating the previous record set in Trump’s first term. Despite achieving none of their demands, eight Democrat senators shifted position to vote through the spending bill, which was subsequently passed by the House and signed by the President. Having forced the shutdown over health care costs (specifically the impending end of enhanced Obamacare subsidies), ultimately, they relented with no change to the policy. However, after wins in a number of recent elections they may feel that the point has been made and they can successfully pin the rises on the Republican party in their aim to win back control of Congress at the mid-term elections next year.
While Federal workers are coming back to work it may take time for normal service to resume. On the economic front there have been a significant number of missed data releases and as this economic data is gradually released, we may see greater volatility as investors digest what they’ve missed. Of the non-governmental data released there have been mixed signals. The latest ISM survey data showed weakness in manufacturing albeit with better news on new orders and prices, while Services data remains strong. Consumer confidence appears to have fallen sharply while employment data remains confusing with mixed signals from different measures. All will become clearer as data is released, albeit there is a swathe of economic data that has not been collected, which may add variability into what is released.
This makes the work of the US Federal Reserve even more challenging. Under significant pressure from the President to cut interest rates, they duly did so last month but next month’s decision looks like a coin-flip (albeit in the US not a penny) with inflation still elevated. However, the market expects three or more cuts next year as Trump gets to stack the Federal Reserve with more supportive members in the new year, when Fed Governor Powell’s term ends (although he stays on the committee) and with the retirement of Governor Bostic in February. He may also get to replace Governor Cook if the Supreme Court allows it; they are hearing that case in January. More recently the Court have been looking at tariffs and from the initial arguments it seems that even Trump-appointees think he may have overstepped the mark. However, it remains too early to call and is unclear what remediation may be required (it is unlikely that tariffs will be paid back) but it may yet introduce further uncertainty for businesses.
UK perspectives
Here in the UK, Rachel Reeves might wish that the government was shut down and there were no economic releases. With just two weeks left to the budget, recent data has only added to the gloom. The latest economic growth data showed that the economy unexpectedly shrank in September dragging down Q3 economic growth to just 0.1%. Meanwhile the most recent employment data showed unemployment rising to 5%, while wage growth slowed. This economic weakness increases the chance of interest rate cuts and it looks likely that the Bank of England will cut rates in December. Bond yields already reflect this to some degree with yields down 0.25% over the last month and weakness in Sterling. Expectations are that the Bank will continue cutting rates in the New Year, which should see bond yields and Sterling continue to fall but that may depend on the state of the government’s finances and the budget.
While it would be unfair to solely attribute this weakness on measures taken at the last budget, it does seem increasingly clear that increasing national insurance contributions on employing workers has had a detrimental effect on employment and growth. Of course this is completely unsurprising, taxing behaviour leads to less of that behaviour, so be careful what you tax. Ultimately this is the dilemma facing the Chancellor at her next budget. Cutting spending seems impossible, despite the government’s huge majority, and so faced with fiscal challenges the only question is what to tax. Having committed to not raise any of the major revenue generating taxes (income tax, national insurance and VAT) on “working people” the room for manoeuvre is limited but it is to be hoped that some lessons have been learnt. Early indications are that the pledge on income tax may be broken, potentially offset by a fall in national insurance contributions, but we expect other tax rises, which may create economic distortions and potentially be detrimental to future growth.
Earnings continue to deliver
It can be easy to get gloomy when thinking about the budget and the fragile state of the UK finances. However, markets continue to perform strongly. The third quarter earnings season is almost over (Nvidia reports next week) and earnings growth has been very strong with Q3 earnings growing over 13% year on year in the US (S&P 500), primarily driven by technology stocks. While valuations remain high, continued earnings growth and monetary easing through interest rate cuts provides ongoing support for equities.
Gareth Thomas
Head of Investment Management
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