Kathleen Brooks
Minerva Analysis
All eyes on Westminster as we wait to see if Hunt will quell market concerns on the UK's fiscal outlook
As FX trading gets underway in Asia late on Sunday, the dollar has slipped yet again, which is a continuation of the move from last week, when the dollar fell 3.5% on a broad-basis and US stocks surged 6%. The market mood appears upbeat as we start another week, as expectations of a Fed pivot, China dropping its zero covid policy and the Russian withdrawal from the strategically important Ukranian city of Kherson all helping to boost sentiment. The key driver for risk sentiment remains weaker US inflation data, which focussed minds on the longed-for pivot from the Fed to smaller rate increases. This narrative was given a boost on Friday when the University of Michigan consumer confidence indicator for the US came in lower than expected across all measures for November. Right now, weaker data is good news for the market as a slowing economy also builds the case for a Fed pivot. As we start a new week, the UK Chancellor’s Autumn Statement (and UK Budget version 2) is scheduled for Thursday, UK inflation is released, along with a raft of Chinese data, US retail sales and US producer prices. To add a political twist to the mix, the Democrats have won the Senate race in the Midterms after they won Senate seats in Arizona and Nevada, and a Republican victory in House of Representatives has not yet been called.
Democrats hold onto power: the market impact
Looking ahead, the market had been expecting a Republican win in the Midterms, yet that has failed to materialise. For outsiders, this highlights how the Trump brand is now toxic for the Republican party, and with heavy losses dealt to his favoured candidates this has reduced the likelihood that he will run in the 2024 Presidential race. While a divided Washington is usually good news for financial markets, right now the Democrats continue to hold the sway of power, controlling both the White House and the Senate. On the surface, this could be bad news for stocks, however, there are three reasons why this is not such a bad result for US asset prices:
1. If this causes Trump to step aside from the 2024 Presidential race, then it could signal a return to a more convential and centrist political style in the US. This is good news for financial markets as it makes the future of US politics and policy-making more certain and less wayward, which is surely a good development after the turmoil thrown at financial markets in 2022.
2. Nancy Pelosi, the Democratic speaker of the House of Representatives, is calling for a vote this year on the US debt ceiling before the new Congress is sworn in. US Treasury Secretary, Janet Yellen, has also said that it would be “great” to get this done this year. No wonder these two key Democratic figures are calling for the vote on the debt ceiling to take place ASAP, the Midterm results mean that the Republicans are not as emboldened as some expect, thus raising the debt ceiling without a standoff or potential tough spending cuts is possible. This eradicates the prospect of a debt ceiling wrangle and a potential US default, which is a good thing for global financial markets.
3. The prospect of a Fed pivot is still the key driver of markets right now, and that supersedes politics at this stage of the financial cycle. Could weak US retail sales also push the Fed to slow down plans to shrink its balance sheet? We think yes, thus the ‘bad data is good for financial markets’ theme may have some way to go this month.
Overall, political developments in the US also support a continuation of the stock market rally that we saw last week, although we may not get such large moves to the upside as issues remain: weak Q3 earnings and a weak Q4 outlook, a dreadful outlook for key lead economic indicators such as the semi-conductor industry and the prospect of a weak economic outlook in 2023, which could temper market exuberance in the coming days and weeks.
The Autumn statement: what to expect
The UK is also in focus this week, with the Chancellor’s Autumn Statement due on Thursday. As we mention above, this is the UK’s second attempt at a Budget in just shy of two months after the disastrous mini budget back in September. The mood music is very different this time around, with the Chancellor expected to cut spending and raise taxes for nearly every tax-paying cohort. Accompanying this statement will be the Office for Budget Responsibility’s forecasts for the UK economy, with all eyes on the OBR’s projections for UK debt to GDP levels, and whether the Chancellor’s medicine will fix the UK’s over-borrowing problem.
Watch the OBR forecasts
Chancellor Jeremy Hunt is expected to announce spending cuts and tax rises totalling £55bn, which should cover the UK’s fiscal hole, however, it could wreak severe economic damage in the process. On Sunday, Hunt said that everyone will pay more tax, however, he is saving the specific detail for Thursday. There is a potential that he will reduce the threshold for the top level of tax to £125,000, and he is also expected to impose road tax on electric vehicles, they are currently exempt. However, these measures are unlikely to be enough to plug the UK’s fiscal gap. Instead, Jeremy Hunt has mentioned how expensive the UK’s support for household energy bills is, and he will announce the revamped plan this Thursday. This will obviously be less generous; however, Hunt was clear in interviews this weekend: sound money comes before fiscal help to protect the economy from recession. With news that the UK’s economy has already contracted by 0.2% between July and September, and the BOE is predicting an historical recession for the UK economy of 5 quarters of negative growth, will the market like the UK government’s tighter fiscal policy?
Will the Chancellor over-correct?
The market impact from this Budget is unclear, but one thing that we will put our neck out for is that the market reaction won’t be as violent as the September Budget, and no pension fund should go under because of Jeremy Hunt’s fiscal changes. One the one hand, with UK inflation expected to top 10.7% in October when it is released later this week, tight fiscal policy could help to bring down inflation, which is good news for the economy and a sensible economic path to take. However, there is a risk that the Chancellor will over-correct the mistakes made by Kwasi Kwarteng. If this narrative takes over, then we could see a mild decline in UK stocks and the pound in the days after the Autumn statement. Overall, watch the OBR forecasts and bond yields, we expect them to fall because of this budget. The BOE could also get a boost as this Budget could finally trigger a downward shift in market-based interest rate expectations for the UK, something that the BOE has been calling for in recent weeks.
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