Labour’s Expanding Fiscal Black Hole

Black holes can increase in size by accreting matter, such as by swallowing stars that get too close, or by merging with other black holes.

I read that on Google. Sounds rather like Labour’s fiscal black hole, doesn’t it? It keeps getting bigger and it appears this will cover raising taxes and squeezing the middle classes until the pips squeak for years. First, it was £22bn, which then became £40bn and then rose to a whopping £100bn.  The latest thing to be trailed is amending CGT. They will amend fiscal rules to borrow more to invest, that is certain.

Trump’s Potential Return Boosts Dollar, Bitcoin, and DJT

The pound, and the euro are offered and the dollar is bid this morning as markets really price in a Trump election win and focus attention on what the ECB is about to do next. The euro trades at its weakest against the dollar since August 2nd – well priced for the ECB stepping up the cutting cycle.

The Trump trade has been showing up with DJT up 50% in the last 5 days, and Bitcoin trading has been at its highest since late July. These are pretty high beta proxies for Trump and indicate a momentum shift in recent days. The market is saying Trump will win. It can get it wrong, but I wouldn’t take the other side of that bet. The Trump trade is part of this strong dollar move, but we also see a sense of the BoE and ECB coming back to where they ought to be in terms of lower rates, which is reflective of their weaker growth economies.  

Mixed European Equities

The FTSE 100 rose 1% yesterday as UK equities outperformed on that lower inflation reading, which pushed gilt yields and the pound lower and saw markets price in swifter and deeper easing by the Bank of England. This morning, London opened flat, and the CAC and DAX pared back some losses from yesterday. Another press briefing from the Chinese authorities was a bit disappointing, and Chinese equities were mixed at the start but ended sharply lower during the session. The Hang Seng tested the 20k level for a three-week low, having retraced half its monster rally from the middle through to the end of September.

Wall Street vs Main Street

The Dow rallied another 300pts for a fresh record high – some hot numbers from Morgan Stanley really capped off a strong earnings season for the big banks of Wall Street. The S&P 500 added 0.47% to 5,842.47, with MS up 6.5%.

Why are stocks still rising? One point made by Fundstrat is simple enough: “.. core inflation has fallen like a rock from 7% 3Q22 to 3% 3Q24 .. yet revenue growth has held steady .. this means that ‘real’ revenue growth is accelerating .. and implies that the quality of 3Q24 EPS growth is stronger than a year ago. Perhaps this explains why stocks are so strong.”

But it ain’t all rosy out there on Main St: 43% of the Russell 2000 companies are unprofitable, the most since the Covid crisis. At the same time, interest expense as a percentage of total debt of the Russell 2000 firms hit 7.1%, the highest since 2003, says Apollo/BBG. As a result, the Rusell 2k has not exceeded its 2021 all-time high.

GBPUSD – pushing towards the bottom of yesterday’s range.  

ECB Expected to Cut Rates Amid Slowing Inflation

The ECB is generally expected to cut rates by 25bps following a slowdown in inflation and wage growth. The Eurozone's annual inflation rate was 1.8% in September 2024, down from 2.2% in August. The flash PMI for September also shows average prices charged for goods and services rising at the slowest rate since February 2021.

On Friday, September 27th, data showed France’s combined goods and services CPI was the weakest on record for a September. And we have seen the softest Sep MoM goods inflation since '09. It was also the weakest Sep MoM services inflation on record. Overall, prices fell by 1.1% in September from the prior month, according to the revised figures, though we can point to the Olympics as a potential cause. Nevertheless, it just adds to the rather gloomy picture emerging in Europe.  

Dovish noises  

Policymakers have sounded on the dovish side ahead of the meeting. French central bank chief Francois Villeroy de Galhau said a cut is “very likely” and such a step “won’t be the last”.  Bundesbank Chief Joachim Nagel, one of the most hawkish members of the Governing Council, said he’s willing to talk about an interest-rate cut. ECB President Christine Lagarde has made it pretty plain that a cut is the most likely outcome amid weakening economic growth and a sharp fall in inflationary pressures. She said latest developments had strengthened the central bank’s “confidence that inflation will return to target in a timely manner,” and said this would be taken into account in October.  This was seen as a pivot away from the ‘gradualist’ approach she was evincing at the September 12th meeting. Chief economist Philip Lane has said the ECB would need to step up rate cuts as the outlook worsens.

Assuming a cut is coming, the market will be most concerned about the guidance for future cuts and whether the ECB signals that it needs to catch up a bit. But we should not assume a cut is a given – in September, the ECB was pretty confident that a gradual pace of easing would be fine. It lowered growth forecasts and stuck to this line – has all that much changed since then? Certainly, inflation has come down a lot, but services inflation remains around 4%. Given that the Governing Council seemed to be taking a more gradualist approach in September, a cut this week would signal a willingness to favour growth over any lingering inflation concerns.  It could also signal that the ECB feels it got too far behind the curve by playing it cautiously.  

Hawkish Surprises from the ECB?  

Remember, the ECB staff projections in September have already factored in lower growth, whilst the recent move lower in the inflation rate suggests it will undershoot the forecasts, with staff projections having anticipated a slight uptick at the tail end of the year. So, whilst they are very likely to cut, they could have a hawkish surprise in store in terms of the guidance – markets are already well priced for easing, with the euro sinking to a two-month low ahead of the meeting. The ECB can’t stay too far behind the curve for too long, but anything remotely leaning toward September’s gradualist approach could produce some hawkish repricing in the front end and strengthen the euro, even if this does not last for long. And we could yet see the ECB hold fire – dovish hold or hawkish cut seem to be the two most likely scenarios. They are not ready to give up yet, though markets may well see a cut this week as the ECB tacitly, if not openly, admits they are ditching the more gradual approach.

Yet, the divergence in the economic performance of the US and Eurozone suggests further euro weakness could materialize as markets reprice expectations for the Fed’s and ECB’s respective terminal rates. In that sense, a cut today or holding fire is less important than it may appear at first. A trade war, should one occur in the event of Donald Trump winning the presidency, would be another negative euro factor to consider in the monetary policy details. Markets are pricing in 2 more 25bps cuts this year and a further 100bps next year. Ultimately, for the euro, the pace and timing will matter less than the ultimate destination – as well as what happens in the US.