Latest European economic and market outlook.
Economic momentum continues to ebb away in the US. This can be seen in the ISM index, which fell to its lowest level since 2009, raising concerns of a manufacturing recession. Meanwhile, slower job creation suggests that the labour market may be hitting its peak. Thankfully, data has been more encouraging in other areas of the economy. For example, strong retail sales and higher wages show that consumer spending should continue to support growth. With regard to the trade negotiations, it is extremely difficult to forecast the eventual outcome. We have been pessimistic for some time, believing that many of the issues are intractable. However, our network of experts and politicians is becoming more constructive, arguing that there has been sufficient deterioration in the US economy and political backdrop to warrant some concessions to the Chinese in return for more agricultural purchases. Data certainly suggests that Trump’s approval ratings are suffering from incremental tariffs. Moreover, we note that the Chinese have recently increased their agricultural purchases twice. Hopefully this will be enough to persuade the US to at the very least maintain the status quo and not ratchet up tariffs further. If trade tensions do deteriorate again, we expect this to be in the form of restrictions on capital flows or technology access rather than further tariffs.
Europe also seems to have shifted to a lower gear of growth. Germany and Italy, the Euro Area’s largest and third-largest economies, are both on the edge of recession, while inflation in the region remains well below the ECB’s target. Consequently, the central bank unveiled a fresh stimulus package in September, loosening policy for the first time since 2016, as it tries to revive growth and inflation. Its task is being made more difficult by the ongoing uncertainty over Brexit. While the UK has passed legislation that should in theory eliminate the risk of a No Deal exit at the end of the month, Boris Johnson remains resolute that the country will be leaving on 31st October. This has raised concerns that he might provoke another EU member state into blocking a further Brexit delay over fears that a mutinous UK would become uncooperative.
The UK economy remains subdued, with PMIs in both the services and manufacturing sectors deteriorating in recent months. On the upside, unemployment is now at the lowest rate since 1974, which is helping to support the fastest increase in nominal earnings in over ten years. This should bode well for private consumption growth and help offset persistent consumer pessimism. Of course, the economic trajectory of the UK will depend heavily on the outcome of Brexit negotiations over the next month. A No Deal will almost certainly inflict serious economic damage in the short term, although the chancellor has promised to pump billions into the economy to cushion the blow, while the Bank of England has hinted that interest rates are likely to be cut, even if the UK avoids a No Deal.
It is interesting to note that, at least from a Chinese earnings perspective, the trade war is having less of an impact than initially feared. Looking at the most exposed industrial Chinese A-share companies, their revenues have missed by 2% on average, yet earnings beat estimates by 7%. This suggests that tariffs have been offset by falling material costs or that these companies have been able to pass on the tariffs successfully by squeezing suppliers. Either way, it is a good sign. Another good sign is that the Chinese government has allowed more bond issuance to finance various infrastructure projects. This suggests that Beijing recognises that Fixed Asset Investment has been too low and that further loosening will be required. At the same time, data out of the Chinese property sector has improved, which could boost consumer confidence and support a recovery.
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