Weekly Update - Reasons to be careful? Part 3

In the US, the gap between Democrat demands for over $2tn in new stimulus and Republicans’ reluctance to go above $1tn, combined with strong job data for August, appeared to have ended any chance of deal being struck before the presidential election. However, on Wednesday this week, Donald Trump called on Republicans to agree to a $1.5tn package and his staff restarted negotiations with Democrats to push a deal through.

In our view, the package is necessary. Much of the support contained in March’s Coronavirus Aid, Relief, and Economic Security (CARES) Act is set to come to an end. For example, the extra $600 per week in unemployment benefits expired at end-July and President Trump’s August executive order to pay unemployed workers $400 per week will shortly run out of cash. The 12.6 million Americans currently filing jobless claims face a cut in benefits of over 50% if Congress fails to reach agreement.

On Wednesday, Federal Reserve (Fed) chair Jerome Powell called for a new relief package for the US economy, underlining that the lack of additional fiscal support was a big downside risk to the outlook. Unemployment is still far too high and inflation – as measured by prices of core personal consumption expenditure (core PCE) – is stuck well below the Fed’s objective of an average 2% over time.

Relations between London and Brussels have deteriorated over the past week, in reaction to the introduction of a new Internal Market Bill by the UK government. This legislative initiative, if successful, would override last October’s Withdrawal Agreement in respect of the Northern Ireland protocol on state aid and customs declarations. Not surprisingly, this is viewed by the EU as a breach of international law and the European Commission has called on Westminster to abandon its plans, albeit while underlining that EU-UK talks on the future relationship should continue regardless.

The new bill has also been poorly received in the US. Both House majority leader Pelosi and Democratic presidential candidate Biden have stated that there would little chance of Congress approving a trade deal with the UK if the bill passes into law. This is because that it would imperil the Good Friday Agreement, which brought peace to Northern Ireland and which is predicated on an open, frictionless border with the Republic of Ireland.

Of course, the bill’s introduction could yet prove to be an attempt to wring extra concessions in the trade talks with Brussels. Last year’s volte-face to sign the Withdrawal Agreement may prove to be this year’s template. But undeniably, the risk that there could be no deal when the UK finally leaves the single market and customs union at year-end has risen markedly this week. The Bank of England’s economists expect that this would reduce GDP by between 2.5 and 5.5% to the end of 2024. So far however, this is not the BoE’s central scenario – indeed, yesterday’s policy meeting left rates and asset purchases unchanged.

Bottom line. In the US, President Trump’s intervention may prove sufficient to reconcile Democrat demands and Republican resistance. Nancy Pelosi has indicated approval and Senate Republicans will be reluctant to be accused of imperilling Trump’s re-election chances. However, the outcome remains highly uncertain. In the UK, the risk of a hard Brexit has risen but we still believe that pragmatism will prevail and a deal will be struck. But whatever the outcomes in the US and Europe, central banks stand ready to ease further if necessary, which would provide further support for risk assets.

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