Market outlook: Britain braces for the Budget as US prepares for polls

The US presidential election race has dominated headlines in recent weeks in what appears to be a dynamic and intense race. With significant developments happening regularly, the US election winner is very much still an unknown. As markets face heightened levels of uncertainty and global growth slows, Craig Hoyda, investment manager at abrdn, reflects on the issues affecting the global economy and importantly what the implications are for investors.

Growth slows but recession woes fade

We are indeed seeing signs that the global economy is slowing down, but we expect a gentle slowdown rather than a severe recession. Although US unemployment is rising, we believe we’re not headed for a recession this time. However, we’re not quite out of the woods yet as the risk of a severe downturn has increased.

To counter this, we anticipate the Federal Reserve (the Fed) will cut interest rates a further two times before the year is out. The Fed delivered its first interest rate cut since 2020 in its September meet reducing the range to 4.75%—5%, a 0.5% cut. This marks an important shift toward ending the central bank’s campaign to tame inflation, but we expect the Fed to reduce the size of the moves going forward, meaning we’ll likely see 0.25% reductions at the remaining two meetings this year. Government bond markets had initially rallied on the size of the cut, however, much of these gains were lost when it became clearer that the size of this cut was a one-off.

As we enter the final quarter of the year, we expect the Bank of England (BoE) and the European Central Bank (ECB) to continue cutting rates further, and many emerging market central banks to follow suit now the Fed has begun cutting.

Japan: the main exception to global easing

Japan, on the other hand, is likely to raise rates, which could cause further market volatility. Early in August, fears of a US recession were prompted after some weak economic data, along with a stock market crash in Japan, prompted a global wave of equity sales.

The Nikkei 225 Index fell by 12% in a single day, the largest downward movement since the late 1980s. With the Bank of Japan (BoJ) raising interest rates and reducing the amount of bonds it would purchase in July – faster than markets were expecting – combined with increased pricing in of Fed interest rates, this led to a sharp appreciation in the Japanese Yen against the US dollar (and other global currencies).

Many investors had borrowed in Yen to invest in higher yielding currencies (known as a ‘carry trade’) and when they then expected the Yen to appreciate, they quickly reversed these positions.

The panic spread and the flight to safer investments led to a large sell off in the stock market, although it must be noted that Japanese firms’ revenue is largely sourced from exports so a stronger Yen harms their top and bottom lines. The US market sold off in sympathy, led by the technology sector and weaker jobs data with news of Warren Buffet offloading part of Berkshire Hathaway’s stake in Apple also feeding the frenzy.

Markets recovered later in the month, helped by some stronger US economic data and the BoJ’s assurance that it would not raise rates during times of instability – something that’s now likely to change.

China syndrome

China’s growth target is also on a knife edge due to ongoing challenges. The People’s Bank of China (PBOC) announced a wide range of policy easing measures which are far more aggressive than anticipated and should marginally reduce the chances that this year’s growth target is missed. A raft of interest rates were cut, bank lending restraints eased and measures were announced to support the property sector. That being said, there is the risk that these measures only paper over the cracks, and without fundamental changes to turn around the property sector then domestically driven growth is likely to remain constrained.

Britain braces for Budget

The prime minister and chancellor have been on an expectations management mission in recent weeks, talking about the difficult decisions that they may end up making in the upcoming Autumn Statement.

But it’s important to recognise that recent UK economic growth has been better – with inflation close to target and rate cuts well underway. The UK economy grew the fastest among G7 countries in the first half of this year, with an annual growth rate of about 2%, which is good for the UK and higher than the UK’s usual potential. Indeed, The Organisation for Economic Cooperation and Development (OECD) its outlook for the UK economy.

Inflation has also decreased significantly, briefly hitting the 2% target, though it has risen slightly and is expected to be around 2.5% for the rest of the year due to energy prices. The underlying inflation pressures, especially from the labour market and services, are also slowing down. This has given the Bank of England confidence to start lowering interest rates, with one cut already in August and more expected in November and into next year. These rate cuts should help reduce economic challenges. So overall, the UK’s economic situation is better than it has been in several years.

It may well be there’s a degree of political theatre or narrative setting going on in the sense that the new government would like it to be the case that the difficult choices they're going to be making in this Budget are associated with the past government. Markets have reacted positively with the pound trading at its highest level (£1 = $1.34) since early 2022, an appreciation of more than 25% since the budget event of 2 years ago.

A slowdown in the eurozone

The recent European parliamentary elections generated some political turmoil due to the success of right-wing populist parties. The decision by France’s president Emmanuel Macron to call an election in the national assembly (where the government is formed) had created fears that one of Europe’s largest economies could soon be governed by the far right. This helped trigger a sell-off in eurozone equities as investors worried about the prospect of unfunded tax cuts against the backdrop of high government debt levels. These fears were slightly unfounded given France’s two-stage electoral process. That being said, it now costs the French government almost as much to borrow over 10 years as it does the Spanish government at the time of writing (around 3%).

For now, we’re now seeing European growth slow again, with the German economy especially weak as it struggles with cyclical and structural headwinds.

The ECB is still worried about underlying inflation risks and while it started its easing cycle ahead of the Fed, it’s possible it may pursue relatively more cautious cutting from here on in.

US election – too close to call

Finally, the US election remains an important source of uncertainty. Vice-president Kamala Harris has secured the support of enough Democratic delegates to become her party's nominee. Harris has made the race much more competitive, even if her economic policies would represent broad continuity from those of President Joe Biden.

Meanwhile, the 'Trump trade', or a scenario where Donald Trump becomes the president could lead to greater inflationary pressures. A Trump presidency that pursues these inflationary policies remains one of our key global market risk scenarios.

Our economists’ forecasts are conditioned on a Kamala Harris victory, given her lead in the polls. However, the race really is close to a toss-up as given the intricacies of the Electoral College.

Global political affairs remain unpredictable and could re-ignite inflation pressures in a way central banks are unable to fully anticipate. It’s possible more shocks to supply lines from international politics, climate change or an oil price shock emanating from the Middle East, could lead to more inflation volatility.

Craig Hoyda is investment manager at abrdn.

ii is an abrdn business. 
abrdn is a global investment company that helps customers plan, save and invest for their future.