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The US election has garnered most attention over the last month, and while we don’t have much clarity on the final make-up of the policies of the incoming administration, the impact they might have, or how long they might take to implement, tax cuts and tariffs are the main economic tools favoured by President-elect and the cabinet members he has proposed to date.  Goldman Sachs has estimated that a 10% tariff on all US imports would add more than 1% to US CPI, subtract a little from growth, but knock more than 1% from European growth.

While we await clarity on the economic policies of the new administration in the US, the economic data releases over the last month have continued to shed light on the path of various economies.

US

The US economy continues expand strongly, driven by consumer spending and non-residential investment, with forward-looking indicators even suggesting an acceleration from here (services-led).

The strength of the economy hasn’t prevented core inflation from declining from its peak 6.6% pace seen in mid-2022, but it is worth highlighting that y/y core inflation has remained stubbornly above 3% since June.

And while the Fed should look through any tariff-induced inflation spike as a one-off price adjustment, there is a risk that the scars from prior “transitory” claims could keep rates at more elevated levels than they should.

Another looming debate for the Federal Reserve is when to stop QT.  Reverse repo (cash deposited on overnight at the Federal Reserve, referred to as RRP) has declined precipitously from close to $2.5tln to ~200bln today.  This has meant that the Fed’s QT has had little to no effect on Bank Reserves, which remain north of $3tln.

This metric is key to when the Fed stops QT – when reserves become scarce, turmoil in repo markets ensues, and the Fed will clearly want to avoid a repeat of the “not-QE” t-bill purchases in late 2019.

The issue is, nobody really knows at what level reserves will become scarce, but the Fed is bound to be hyper-vigilant as RRP approaches zero.

Europe

Growth may have surprised to the upside in Q3 (+0.4% q/q), but outside of Spain (+0.8%), Ireland (+2.0%) and France (Olympics-impacted +0.4%), Germany (+0.2%) remained mediocre and Italy didn’t grow at all.

Forward looking indicators suggest a continued downtrend in the industrial side of the economy, the only brightness being the services sector.

Interest rates are too high, enormous fiscal deficits will need to be reined in, and the rise in trade uncertainty following the US election is another headwind for the European economy.

Following the French political turmoil, it is now Germany’s turn, where an early federal election will be held on February 23rd.  Opinion polls have consistently placed the centre-right CDU/CSU group in the lead, with Politico’s polling average putting them on 32%. They’re followed by the far-right AfD on 17%, Chancellor Scholz’s centre-left SPD on 16%, the Greens on 10%, and the new far-left group BSW on 8%. Bringing up the rear are the FDP on 4%, and the Left on 3%, both beneath the 5% hurdle required to enter the Bundestag.

China

We think the announcements by the Chinese authorities in late September are significant, should shore up domestic demand (growth targets are only being reached because of exports) and draw a line under the weakness of the last few years.

However, the appointments by the US President-elect of China hawks cannot be underestimated, leaving the outlook murky.