Weekly View - No red wave

The ‘red wave’ in the US midterm elections failed to materialise, with the Democrats’ win in Nevada meaning the latter will maintain control of the US Senate. While Republicans still may gain a narrow majority in the House of Representatives, president Joe Biden now has more latitude for his legislative agenda and to ensure his judicial appointments go through. The failure of nearly all election-denying candidates he endorsed means that Donald Trump faces challenges from within the Republican party, notably from Florida governor Ron DeSantis, and indicates that US democracy is proving more resilient than feared. Historically, a split Congress has been positive for markets, with one immediate focus of attention likely to be the chance of a less confrontational approach than before to raising the federal debt ceiling before year’s end.

Markets rallied strongly on news that US consumer inflation dipped more than expected last month. Ten-year yields moved below 4%, a 50bps hike in the Fed funds rate next month was seen as much more likely than a 75bps one and markets lowered their forecast for the terminal Fed funds rate to below 5% from 5.25%. Nevertheless, the fight against inflation may not be over as the November University of Michigan survey shows consumer inflation expectations rising to 5.1% for the year ahead and to 3% annually for the next five-to-10 years. The Cleveland Fed’s ‘nowcast’ of median consumer prices also suggests underlying inflation remains persistent. The decline in yields and anticipated moderation of Fed hiking meant the US dollar declined, suffering its biggest drop since 2009 on Thursday, while gold rallied. A possible slowdown in Fed rate hikes (and potentially a lower terminal rate) narrows policy divergence with the European Central Bank (ECB). A narrowing of the interest-rate differential with Europe would support the euro against the USD.

Recent data on trade, inflation and credit demand show the Chinese economy continues to falter. But there has been some important positive news as well, including the unveiling of important new policy support to help the stricken property sector. The prospect that policy measures will at least stabilise conditions in the sector is helping push Chinese equities higher and reviving the much beaten-down Chinese high-yield bond market. Just as importantly, China’s National Health Commission announced an easing in quarantine conditions for close contacts and inbound travellers. Together with a commitment to accelerating vaccine roll-outs that allows progress towards gradual reopening, this is also boosting Chinese assets. Meanwhile, the collapse of FTX, a high-profile crypto exchange, vindicates our caution on crypto given inadequate security and regulation. This week, we will be watching the G20 summit, and particularly from Biden’s face-to-face meeting with Xi Jinping’s before the Summit, for any sign of a stabilisation in US-China relations.