The Weekly - Global Stalemate

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12/11/2018
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The midterm elections in the United States can be a little confusing if you don’t follow American politics, especially when both the Republicans and the Democrats have claimed victory. Coverage in the UK media has never been more intense, and the reason is simple; these elections are the first litmus test of a very controversial president, Donald Trump, or as he referred to himself immediately after the election: ‘the magic man’.  He is so divisive that we are surprised Marmite owner Unilever hasn’t sued him for metaphorically adopting their love it or hate it campaign – after all, the American public do either love him or hate him.

So, the real question is whether the midterm elections were as successful for Donald Trump as much as he made out. The answer is somewhat complicated, and the best place to start is by looking at his predecessor, Barack Obama, and how he performed at his first midterm election in November 2010. In every midterm election, seats in both the House of Representatives and the Senate are up for contention. These two houses are collectively called Congress.

In both the 2010 and 2018 elections all 435 seats in the United States House of Representatives were contested. In 2010 the Republicans gained 63 seats and took control of the House, whilst in 2018 the Democrats have gained at least 34 seats (10 races have yet to be called), however, this was still enough to take control of the House. Also, in 2010 there were 37 seats in the Senate being contested, while in 2018 this figure was only 35. In 2010 the Republicans gained six seats increasing their minority, but still fell short of the majority they required. Overall the 2010 midterm elections were a disaster for the Democrats. The Republicans finally won their majority in the Senate in the presidential election of 2014 and in the 2018 midterms last week they went further and increased their majority further (two seats have yet to be called). So, when comparing the two midterm elections side by side and, given that no blue wave materialised for the Democrats, then we would say that last week’s midterms narrowly favoured Donald Trump. Given that despite midterm mishaps Barack Obama was able to secure a second term, then last week’s midterm election demonstrates that a second term for Donald Trump is entirely possible.

Given that the election of Barack Obama was made on a wave of optimism with chants of ‘yes we can’ the Republicans ensured that this optimism was misplaced and made life very difficult for the rest of Barack Obama’s first term and then also his second term.  You only have to look back to the United States government funding crisis of 2011 and 2013. Previously this had been routinely passed on a bipartisan basis, however, members of the Republican party in Congress opposed the raising of the debt ceiling leading to a government shutdown. Eventually a compromise was reached, but this type of scorched earth policy was often deployed by the Republican party to frustrate Democrats and their President, Barack Obama. 

The United States might be anything but united, but will this have a negative impact on financial markets?  We don’t believe so.  In fact, after the result most US indices were up mostly on the removal of the uncertainty. If Donald Trump had lost control of both houses, then we would have entered a period of instability. The Democrats could have unwound Donald Trump’s tax cuts which would have caused market turmoil and, going further, they could have started impeachment proceedings.  They could still implement proceedings, if Robert Mueller’s report – when released – shows collusion between the House of Trump and the Russians. However, given that the Republicans control the Senate this particular avenue would be a very difficult path to go down and, likely, would probably damage the Democrats more than Donald Trump or the Republicans.

In conclusion, whilst this certainly wasn’t the midterm blue wave that the Democrats were hoping for, we feel rather than trying to frustrate Donald Trump they would do better to focus on the 2020 presidential election. After all, trying to frustrate Donald Trump will only play into his hands. The Democrats need to focus on a candidate that not only has a chance of toppling Donald Trump but is also able to communicate clear policies to the electorate. Who that candidate will be is anyone’s guess but shouting at Donald Trump from the side-lines is not going to change his fortunes.     

In news a little closer to home, it seems that British Politicians are equally divided.  Jo Johnson, the younger brother of Boris, and a remainer, resigned from the Cabinet over his dissatisfaction with the direction of Brexit.  While his older brother divides opinion, this cannot be said for the brother with less pomp and circumstance.  Given this resignation, we would say that Theresa May’s position as Prime Minister is looking very precarious once more.  Ordinarily, we would say that there is the very real chance she won’t be Prime Minister come Christmas but given that any incoming Prime Minister will have to conclude Brexit negotiations, that might be a poisoned chalice few would be willing to drink from. Both the brexiteers and remainers are being critical of the Brexit deal that Theresa May has put forward so it is highly unlikely that Parliament will vote it through, which will leave no deal as the only option, and again, it is highly unlikely that this will be voted through either.   However, this is the default option rather like procrastinating about a decision to do nothing.  This will only leave one option, and that will be staying in the EU, or even worse, another referendum.

The Irish backstop certainly seems to be the primary hurdle to concluding negotiations with the EU, with neither side willing to meet in the middle or compromise. What does this mean for UK markets? Uncertainty leads to volatility and given the developments over the weekend the pound has fallen against most other currencies. Nevertheless, despite Brexit uncertainty the FTSE 100 and 250 are still up since the vote to leave on 23rd June 2016. They may have lagged most overseas indices, but should there be any positive developments surrounding Brexit, then we would expect UK markets to perform strongly.         

Sunday marked the centenary of the armistice that ended the first world war. While nothing is comparable to the devastating loss of life and damage that the first world war caused, we find it somewhat unacceptable that again politicians on every side are unwilling to compromise and work together to find solutions to many of the problems we face today. A policy of entrenching oneself didn’t work then, and the way that many politicians are seemingly entrenching themselves now around certain policies doesn’t help the collective.  We all deserve better which has possibly fuelled the rise of populist politics but with that has come nationalism as President Macron so eloquently reminded Donald Trump in Paris.  He declined to attend any other of the planned collective meetings which so illustrated his unilateral America First view.  At least democracy has made his quest more difficult after the midterms such that some of his more extreme ideas will likely fail to materialise.

US market responds to midterm results

The S&P 500 rose +2.1% last week as midterm elections saw the Democrats gain control of the House of Representatives while Republicans held on to their majority in the Senate, broadly in-line with consensus forecasts(1, 2). 

A modest relief rally followed the election result as the divide in Congress may lead to increased legislative gridlock for the rest of US president Donald Trump's term and a reduced likelihood of extreme policy. In addition, a Democratic House opens the door for a barrage of congressional investigations on the Trump administration.  Meanwhile, the US Federal Reserve’s latest policy meeting last week concluded with no change to interest rates, having last raised them in September. The Fed maintained a relatively upbeat outlook as the US labour market and economic activity still appear robust. Expectations are for another rate rise at the final meet of the year in December.

The UK’s FTSE 100 closed the week just +0.2% higher following a fairly muted week(1, 2).  Third quarter Gross Domestic Product data published on Friday was in line with expectations at a quarterly rate of +0.6% economic growth(1, 2). However, much of the growth was attributed to warm summer weather and England’s performance at the World Cup early in the quarter, after which growth stagnated throughout August and September.

Chinese exports increased +15.6% year-on-year in October, comfortably ahead of most economists' expectations of a slowdown(1, 2).  Trade wars with the US had led many to expect a fall but exports were arguably aided by a weaker currency and may still be influenced by advanced orders ahead of the tariffs coming in.

President Trump levied a second round of economic sanctions on Iran last week, targeting oil, shipping, and banking sectors.  The Iranian President vowed that the country will break the sanctions as it deems them unfair. US oil inventory data added to recent pressure on oil prices which lost more ground last week; West Texas Intermediate (WTI) falling into bear market territory, down -21% from its recent peak(1, 2). Over the week WTI and Brent crude were down -4.3% and -3.5% respectively(1, 2).

 Source: Forex Factory (1)

Source: (2)

The Week Ahead

The domestic employment market comes back into focus this week with the latest ONS report due tomorrow. Average wage growth is expected to have risen to +3.0% over the 3 months to the end of September, a +0.3% improvement over the previous data(1). If proven accurate, it will be the quickest period of growth since 2015. Unemployment meanwhile is forecast to have remained unchanged at 4.0%(1). Other home related numbers to keep an eye on include CPI inflation and retail sales. The US also releases inflation and retail sales data this week, the latter of which is forecast to have grown for an 8th consecutive month. Elsewhere, Q3’18 GDP data releases are due from both Japan and the Eurozone(1). The Japanese economy is expected to have contracted over the period, a significant reversal from the +0.7% growth seen in Q2(1). The Eurozone reading is expected to be unchanged from the +0.2% initial calculation reported 2 weeks ago although weaker than forecast German data could impact the headline number(1). It’s a particularly busy week for China with several major releases due on Wednesday including the likes of fixed asset investment, industrial production and retail sales.
 

Source: Forex Factory 2018(1)