The economic effect of US midterm elections
After the winter of discontent and the summer of strikes, you may wonder what is next? Well, US midterm elections are on the schedule for 8 November this year. Seasonality shows that financial markets, on average, bottom before midterm elections. Yet this low was heavily contested by a recurring weakness in June.
This year, in fact, we could even expect the June low to be the seasonal low, as the collapse in sentiment was so extreme. Granted, the situation does not seem much better by now, but this is what stock market bottoms have in common: they look quite dire on the ground. For example, Europe still faces an energy crisis.
How will central banks behave?
Then central banks remain front and centre in terms of pain points. This week is about the European Central Bank (ECB) hiking rates in complete contrast to what it has been doing over the past decade. Finally, the global economy will be more and more characterised by sluggish growth rather than inflation going forward.
A more positive outlook
Given the apocalyptic media coverage over the summer, we want to put things into perspective. Regarding the energy crisis, we continue to highlight that the fundamental situation is much better than alarmistic headlines would make you think. Further spikes in energy prices are likely, while the overall price trends keep rolling over.
Meanwhile, we expect a variety of macroeconomic numbers with a particular focus on China, as a lot of inflation, output, and monetary numbers are due there this week. Despite all of this, we think it is high time to start talking about US midterm elections as gridlock looms. If you were looking for challenges, there are plenty of them in the weeks ahead. In the meantime, it is key not to get carried away by negativism.
A closer look at the ECB
In terms of central banks, we see the US Federal Reserve as having passed the peak in hawkishness, and the ECB will likely follow this trajectory with its meeting on 8 September. Apart from rate hikes, the main focus will be on how the ECB plans to deal with its asset purchases.
The ECB appears quite determined to hike interest rates further this week, with a large rate hike of 75bps becoming increasingly possible. There is growing support among ECB policymakers to accelerate the speed of rate normalisation. In its last meeting, the ECB shifted the deposit rate from -0.5% to 0.0% and hiked its main refinancing rate to 0.5%. Since then, inflation has increased further to 9.1% in August. This keeps the pressure high to push up interest rates faster towards a more neutral policy stance.
At the same time, the ECB must perform a balancing act, as higher interest rates increase the current economic headwinds from high energy prices, worsen the outlook for fiscal sustainability in highly indebted countries like Italy, and complicate the economic response to overcome the supply issues that contribute to rising inflation.
A more gradual approach of hiking rates by just 50bps this week and by another 50bps in the coming month would allow for a better monitoring of the economic risks that are associated with a tightening of monetary policy. We expect the decision on 8 September to be a very close call between an interest-rate hike of 50bps or 75bps.
The eurozone economy can digest a tighter monetary policy up to a certain level. We estimate that a level of 1%–2% marks a neutral level of interest rates that neither supports nor slows economic activity. This level will most likely be reached only later this year.
Should the ECB need to hike rates well above this range, as is currently implied by the pricing of money markets, the economic slowdown that is already now under way would certainly accelerate into a full-grown recession. We expect the ECB to turn away from such an aggressive tightening, helped by an eventual peaking of the current inflation pressure that is largely driven by higher energy prices.