Trade concerns having fizzled out over the summer, have come to the fore again, centred on China and rare earths.  In a very long social media post, President Trump reacted to China’s imposition of export controls on rare earths with a threat of 100% tariffs on all Chinese imports from November 1st and called into question whether he would even meet President Xi at the APEC summit in Sout Korea at the end of this month.  This led to some volatility in equity markets and subsequent walk-back by the US administration – at present, the proposed meeting will now go ahead, markets are assuming a deal will be reached and the new tariffs will not be put in place.  Time will tell.  In rare earths, China controls 70% of mining, 90% of separation and processing, and more than 90% of the magnet manufacturing market.  Export controls lead to a significant impact earlier in the year – Ford closed a plant, for example, as they had no magnets.  But China’s economy is still heavily dependent on exports.  Both sides have strong hands, and the complacency in markets around this event seems misplaced.

Medium term though, the trends we have talked about for some time remain in place.  The US economy appears to be the only region exhibiting strong growth, driven by investment spending and the AI capex boom, which is accelerating.  However, rate sensitive sectors of the economy are feeling the strain of rates that are still in restrictive territory, despite the resumption of rate cuts from the Federal Reserve.  The European economy seems to be muddling through, but just as the German fiscal stimulus provides a tailwind, headwinds are apparent in the form of French political instability and a fiscal deficit that is too large, a precarious UK budget situation and of course the ongoing war in Ukraine.  China, for all of the small steps made to put a floor under growth, appears to be slowing incrementally.  And looming over all this is the ever-present threat of new tariffs.

US

It is of course very difficult to tell what is really happening in the US economy, given the lack of economic data over the last three weeks due to the government shutdown.  We will get the CPI this week – necessary to calculate the Social Security annual cost-of-living adjustment.  But this makes the Fed’s job even trickier – lumpy economic data due to front-running of tariffs earlier in the year, a clear slowdown in employment growth, a clear acceleration in investment spending, followed by a period of virtually no economic data at all.  Recent events in credit markets have brought heightened focus on those areas of the economy most exposed to both rates and lower income consumers.  The bankruptcies of Tricolor (subprime auto lending and a foreign-born borrower base), First Brand (auto-parts supplier with excessive leverage, liquidity pressures, mismanagement and fraud), concerns about Primalend (subprime auto loans) and CRE-based credit write-offs at Zion Bancorp and Western Alliance have shown clear evidence of a K-shaped economy – low-fare airlines, cheap hotel chains, sub-prime lenders are all suffering, whereas businesses exposed to the high-end consumer continue to do very well.

We also have concerns about liquidity – bank reserves have fallen steadily, and are now hovering around three trillion dollars, a level long-identified as a potential pinch-point. Some of the more arcane workings of the money markets are showing signs of stress, such as the secured overnight funding rate which has on occasion traded above Fed’s upper band.  It isn’t a major concern yet, but one to add to a growing list of concerns that could flare up into a potential source of volatility.

Europe

Having cut rates quite aggressively by ECB standards, officials are making it clear that they intend to stay on hold for a while.  Markets have taken on board this steer from the ECB and assign only a 75% probability to one more rate cut over the next year, although this probability has increased a little over the last month.

While the policy rate is not far from neutral, there remains a distinct lack of any material growth in the European economy.  Furthermore, the ECB has pencilled in about 0.25% inflation in 2027 thanks to the new Emissions Trading System (ETS2).  Inflation is already returning to the ECB’s effective target, but pressure from various countries to cap ETS2 could lead to further downward revisions of the ECB’s inflation forecasts.  The ECB can easily afford to deliver a more accommodative stance.

China

Trade concerns have come to the fore again, and the outlook for the Chinese economy remains heavily dependent on where the tariff levels finally settle.  The current level of tariffs remains very high and will likely constrain growth until more reasonable levels are agreed on.

Written by Pearse MacManus, Director of Asset Management – Head of Macro and Risk Analysis