Latest European economic and market outlook.
The Fed has announced that it will start shrinking its balance sheet in October and stick with plans for further rate rises, marking a historic end to quantitative easing. The move is a vote of confidence in the US economic recovery, which continues apace. Meanwhile, President Trump is seeking to cut the country’s corporate tax rate from 35% to 20%. In a move long demanded by companies, he also plans to shift the US to a “territorial” system under which US companies would largely pay tax only on US earnings, rather than all of their worldwide income. The tax cuts, if passed by the end of the year, would drive a one-off increase of about 11.5% in US expected earnings for 2018. But before lawmakers can put forward tax reform legislation, the Republican-controlled Congress must pass a budget resolution, which would pave the way for Republicans to cut taxes without being thwarted by a Democratic filibuster. Of course, investors remain sceptical at this stage as Trump has so far failed to pass any major bill.
The latest macroeconomic data suggest that the eurozone economy ended the third quarter on a high note. For example, the eurozone composite PMI gained further momentum in September, rising to 56.7. With the economic backdrop increasingly benign, European policymakers now appear to have a window of opportunity to negotiate much needed reforms. French president Emmanuel Macron is clearly keen to do so, having been elected on a mandate to deepen economic and monetary union. He has proposed a separate budget, a finance ministry and a European monetary fund for the eurozone.However, any reform efforts will clearly depend on cooperation between France and Germany. While Chancellor Merkel has succeeded in securing a historic fourth term, the rise of right-wing populist party AfD means that she will preside over a weakened party base and will need to manage the competing agendas of her coalition partners. Consequently, Germany could become more inward looking, potentially undermining the reform debate.
The UK appears to have shifted to a new lower-growth trajectory, lagging behind many other advanced economies so far this year. Nevertheless, with the unemployment rate at a multi-decade low and inflation at a four-year high, the Bank of England is becoming increasingly hawkish, hinting that it is poised to raise rates in the coming months. On the political front, Theresa May has recently struck a more constructive, conciliatory tone on Brexit. The Prime Minister has set out plans to keep Britain in the EU in all but name until 2021. Although Britain will formally leave the EU in March 2019, under Mrs May’s model it would still be covered by all EU rules, European court judgements, the free movement of EU workers and budgetary contributions to Brussels until the transition period ends. This has encouraged business leaders who believe Mrs May’s plan will avoid a cliff-edge Brexit.
Supply-side reform continues to drive consolidation and utilisation improvements in China’s ‘old economy’. This can be seen in the coal sector, where the market share of the largest 4 producers has risen from 50% in 2015 to 70% in 1H17. At the same time, China’s ‘new economy’ appears to be accelerating. Revenue and earnings growth in New China rose 30% and 36% respectively in 1H17. This would suggest that ROEs have bottomed and margins have rebounded. Data paint a more nuanced picture in the Chinese property sector. On the one hand, home prices and inventory levels indicate a healthy balance, while upward revisions to guidance from the major developers indicate an improving outlook. On the other hand, deteriorating credit data suggests that property demand could soften. We will continue to monitor the sector closely, given its importance to China’s wider economy.
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