Over the next few weeks, politics will be a key driver in the world’s three largest economies: the U.S., the European Union and China.
First, the underlying trend of the US economy has improved recently. Following better economic data, our proprietary leading indicators are showing above trend growth. The results of Tuesday’s presidential elections have also removed some near term uncertainty as the current, extremely accommodative. monetary policy is likely to remain under the Obama administration. However, the impending US fiscal cliff, which involves tax increases and spending cuts worth around 4% of GDP is a more important question that needs answering right now. Current assumptions are that a compromise will be reached, resulting in a fiscal consolidation of around 1.5%; however, the journey to reach that compromise will be important for financial markets. We only have to remember the summer of 2011 and how the drawn out debate of raising the debt ceiling led to uncertainty and loss of market confidence which was heightened even further by the S&P ratings downgrade. Just today, Fitch Ratings, which still rates the U.S. “AAA”, has stated that a rating cut is likely in 2013 if fiscal issues remain unresolved.
In the European Union, we are still waiting for the Spanish government to request ECB assistance. It has been two months since ECB President Draghi announced the Outright Monetary Transaction (OMT) program, but as of yet he has not had to spend a cent. Falling Spanish yields and Moody’s affirmation of Spain’s investment grade rating has bought some time, but deteriorating debt dynamics will eventually force them into the program. Greece is also starting to attract attention again as the new budget numbers unveiled last week show a dramatic increase in debt to GDP projections, peaking at 192% in 2014, up from a previous forecast peak of 167% in 2013. Greece continues to require outside support and is looking for more favourable loan terms, although this does not appear to be sustainable as a long term solution. This shaky solution is further hobbled by data showing that weak growth conditions are spreading to the strong core countries, which would lead to downside risks to overall Eurozone GDP.
Finally in China, the Eighteenth National Party Congress commences tomorrow which marks a once in a decade leadership transition. Growth forecasts for Q4 have been reduced from 8.5% in April to a more realistic level of 7.6%, while recent data has stabilised and expectations for a 2009 style stimulus have been removed. However, investors will be monitoring the transition closely to see whether the new leaders will do anything to stimulate China’s economy.
It remains to be seen if the politicians will dance to the markets’ tune, but the continual environment of slow growth and accommodative monetary policy remains positive for fixed income assets.