|Mike Lenhoff, Chief Strategist|
For bond and equity markets, it’s what comes afterwards that has everyone worried, though not more so than the G20, which expressed concern over the weekend about the fiscal cliff. How this will be addressed is now likely to be the chief focus of attention over the coming weeks.
While Congress may take it to the ledge, a deferral of the fiscal cliff is what everyone expects. However, on its own, a deferral can’t reduce the uncertainty created by US fiscal consolidation. From the Fed’s perspective, that uncertainty as much as anything has inhibited growth and rendered monetary policy less effective than it would be otherwise.
According to the Bipartisan Policy Centre (BPC), a Washington think tank, what is needed is a commitment to parameters that circumscribe the negotiations on fiscal consolidation. To that end, it has proposed that Congress should agree broad fiscal targets for deficit reduction and debt sustainability as a means of raising the likelihood of what would eventually comprise a ‘grand bargain’. As the BPC puts it, Congress will still end up kicking the can down the road, but it needs to change the can to mitigate the uncertainty.
Shifting scene, this week sees the start of the transfer of power in China to a new leadership on Thursday at the Party’s National Congress. The process of handing over the leadership does not reach completion until all members of the Politburo Standing Committee (their numbers have been reduced to 7 from 9) have been appointed along with their duties and this is not expected to be finalised before March of next year. However, at this week’s Congress, it is expected that Xi Jinping will be confirmed as the new President of the People’s Republic of China.
Just what this transfer of authority will mean will likely involve a process of discovery but, on the face of it, the economy’s adjustment to a slower growth rate appears to be running its course. This is a big deal because it means that the loss of global momentum attributed to this adjustment is running its course too.
If anything, the recent evidence on the Chinese economy points to a modest renewal of expansionary momentum. Following China’s official purchasing managers’ index (PMI) for manufacturing in October, which rose marginally above 50 for the first time since July, the official PMI October survey for non-manufacturing, which came in yesterday, showed a rebound from September’s index to 55.5. More data is expected at the end of the week when, apart from inflation for October, which is expected to remain unchanged from last month, retail sales and industrial output, also for October, are due and expected to endorse the view that the economy’s transition to slower growth is running its course.
It may be jumping the gun but coming on top of the latest OECD composite leading indicator for China, which also suggests that the adjustment to slower growth has run its course, the emerging backdrop provides what appears to be an impressive demonstration of how adeptly the authorities have applied policy to stabilise the economy.
This should be welcome news not just for global earnings but for top line growth. As illustrated by the corporate results being reported for both the US and Europe, the disappointment lies chiefly with the top line. Earnings growth has weakened but, on balance, this has been better than expected and moreover companies have been able to exercise control over their bottom line through cost cutting.
That is not so for the top line which has been driven by the loss of momentum throughout the global economy. Revenue has disappointed and there is little companies can do about this. However, an end to China’s adjustment to slower growth should bring an end to the adverse impact on the growth of aggregate demand for the global economy.
While the transition to China’s new leadership is a source of uncertainty, equity markets are likely to be consumed by the uncertainty associated with the US fiscal cliff. They should respond well to an Obama victory but they are also likely to remain on edge until they see the ‘change in the can’.