Political spaghetti

It’s low-heat rebellion time at the Conservative Party Conference.

Prime Minister Theresa May is getting attacked from both sides in Birmingham. Former Cabinet minister Boris Johnson and the moderately popular pastor of the political wilderness Jacob Rees-Mogg have both lambasted Mrs May’s Brexit negotiations and strategy. Remainers in her party are angling for a second referendum, with another former Cabinet minister, Dominic Grieve, warning that a “significant number” of backbenchers now support the idea. He even suggested a cross-party bloc could force the issue.

But in reality, no-one in their right mind really wants the top job – at least, not yet. And no-one will vote to give Mr Johnson the keys to No.10 either. So for now, Mrs May appears safe in purgatory. Support her or denounce her, everyone can feel sympathy. Trying to nail down a good deal with the EU – that her warring party can accept no less – is very close to impossible.

In Italy, politics aren’t much rosier. However, the nation’s finances are also rubbish, which led to a chunky sell-off in Italian stocks and bonds last week. On Thursday, the coalition government revealed that the country is aiming for a 2.4% fiscal deficit with its upcoming Budget, much higher than the 0.8% target offered by the preceding government. The 10-year government debt yield jumped sharply to 3.20%, quite a feat considering the European Central Bank’s purchase programme helps to keep European bond yields anchored.

Italian politicians have been pretty blasé, with Deputy Prime Minister Matteo Salvini saying, “Markets will get over it.” Many have taken that attitude before, to the detriment of their nations and their political careers. Italy has the second-largest mountain of debt in Europe, after Greece, at 132% of GDP and is growing at just 1.2%. The path of the coalition is going to create a show-down with other EU members at some point in the near future. We think there will be lots of bad-tempered noise which could make European markets very rocky. But we find it hard to believe the right-left coalition is tough enough to survive a painful clash with the EU and markets. It may simply fold, forcing another election. Some cynics say the government wants another election so that the right-wing Lega Nord will pick up more seats. Watch this space carefully, but don’t be quick to knee-jerk reactions.

Source: FE Analytics, data sterling total return to 28 September

Playing for keeps

US Supreme Court nominee Brett Kavanaugh put on a poor show at the Senate hearings, but the Republican Party has doubled down on the man despite multiple allegations of sexual harassment in his teens. He is widely expected to be confirmed next week after a week-long FBI investigation into the claims of a couple of his accusers. President Donald Trump has come under fire for potentially limiting the scope of the police inquiry, just as Democrats have taken flak for ambushing the confirmation hearings with the allegations at the last minute.

There’s a reason why both sides are sailing so close to the wind over this. The midterm elections will be held on 6 November; it could alter the make-up of Congress and transfer power from the Republicans to the Democrats. That’s why the Republicans are desperate to confirm their justice before the hustings – because the Supreme Court bench sits for life, Mr Kavanaugh would give them a solid conservative majority for a generation. It could change the path of social policy in America. Democrats are equally determined to prevent that from happening, for obvious reasons.

For our part, we believe the Senate will be safe from Democratic clutches, but the House of Representatives may be at risk. Politicians in the House of Representatives only serve two-year terms so all 435 of their seats are up for grabs. Senators serve six-year terms and work a staggered system whereby a third are elected every two years. This year 35 seats are on the table, 26 of them belong to Democrat incumbents. Of those 26, 12 have a significant chance of swinging to the GOP, but only six seats held by Republican incumbents have a chance of swinging to the Democrats. As for the House of Representatives, Republicans tend to lose about 7% of their seats when they have a president in the White House, according to our analysis. Their majority today is just 4%.

It’s not just the Supreme Court and the culture wars at stake with the midterms either. Republicans are worried that a Democrat-controlled Congress will try to roll back last year’s tax cuts. To that end, the Republican House of Representatives passed an extension of those tax cuts, “Tax Reform 2.0”, worth $631bn. It would remove the 2025 expiration date for lower personal tax rates that was implemented back in 2017 (corporate tax cuts were permanent). The Senate won’t be debating the legislation before the election, but it will be able to hear it afterwards. The move is seen as an enticement for people to vote Republican and secure more money in their pocket for longer. It would lead to a medium-term boost to GDP, but also hurt the country long term, according to Congress’s Joint Committee on Taxation. It would push the nation’s fiscal deficit higher, increasing government debt and leading to higher interest rates that crowd out private investment.

The US economy has been doing very well lately, buoyed by strong confidence, investment and spending. This week has started positively as well, with the US and Canada agreeing on a deal to retain a revised NAFTA. The US dropped its aim to scrap the ability for nations to challenge other members’ trade policies in NAFTA courts in return for Canada’s promise to open up its heavily protected dairy industry. Another deal is being talked through with Japan. This is all good news for the US – and the global economy.

There are dark clouds in the very distant horizon, sure. But for now, we think the global economy should continue to run for at least another six months. That’s why we’re happy to remain invested in equities, especially relative to bonds.

Bonds

UK 10-Year yield @ 1.57%

US 10-Year yield @ 3.06%

Germany 10-Year yield @ 0.47%

Italy 10-Year yield @ 3.14%

Spain 10-Year yield @ 1.50%

Economic data and companies reporting for week commencing 1 October

Monday 1 October

UK: Net Consumer Credit, Net Lending Secured on Dwellings, Mortgage Approvals, Money Supply M4, PMI Manufacturing

US: Manufacturing PMI, Construction Spending, ISM Prices Paid, ISM New Orders

EU: Unemployment Rate, Manufacturing PMI; FRA: Manufacturing PMI; GER: Manufacturing PMI, Retail Sales; ITA: Manufacturing PMI

Tuesday 2 October

UK: Nationwide House Price Index, Construction PMI, BRC Shop Price Index

EU: Producer Price Index

Final results: Avacta Group, Ferguson, Revolution Bars Group, SCS Group

Interim results: Inspiration Healthcare Group

Wednesday 3 October

UK: Official Reserves, Services PMI, Composite PMI

US: MBA Mortgage Applications, ADP Employment Change, Services PMI, Composite PMI,

ISM Non-Manufacturing/Services Composite

EU: Retail Sales, Services PMI, Composite PMI; FRA: Services PMI; ITA: Services PMI; GER: Services PMI

Interim results: Tesco

Trading update: Gooch & Housego, Topps Tiles

Thursday 4 October

UK: New Car registrations

US: Challenger Job Cuts, Initial Jobless Claims, Continuing Claims, Factory Orders, Durable Goods Orders, Capital Goods Orders

EU: GER: Construction PMI

Final results: DFS Furniture, DX Group

Interim results: Ted Baker

Trading update: Electrocomponents

Friday 5 October

UK: Halifax House Prices, Unit Labour Costs

US: Trade Balance, Nonfarm Payrolls, Unemployment Rate, Labor Force Participation Rate, Average Hourly Earnings, Consumer Credit

EU: GER: Factory Orders, Producer Price Index