Weekly View - Brothers in arms
Having purged 21 moderate Tory members of parliament (MP) who opposed him on Brexit, Boris Johnson has had to face the resignation of two high-profile members of his government, Amber Rudd and his own brother, Jo Johnson. British politics will provide more excitement this week, as a law is passed in parliament to prevent a no-deal Brexit. We feel the latest developments lower the probability of a no-deal Brexit on 31 October and support a temporary rebound in sterling. Given also that we expect fiscal stimulus in most scenarios, we have moved from an underweight stance to a neutral one on UK equities, although the possibility of election-related turbulence means we remain prudent.
Upbeat news last week included the announcement of high-level US-China trade talks, moves to de-escalate the fraught situation in Hong Kong and the formation of a more EU-friendly government in Italy, which holds out the prospect of less stressful budget talks between Rome and Brussels. Once Europe’s problem child, Greece recorded strong second-quarter GDP, and business sentiment in US services was much stronger than expected in August. While talk of a US recession is premature, not everything is rosy in the garden. The August nonfarm payrolls report showed that jobs growth is slowing. Manufacturing is contracting in some large countries, leaving the world economy running on one cylinder.
Of particular note is the latest drop in German factory output, underlining the weakness of the euro area’s largest economy, which looks like entering a mild, technical recession. This too might be good news should it push the German government toward more fiscal spending. Germany’s woes may also tilt the balance between hawks and doves at the important European Central Bank (ECB) meeting this week. Alas, we feel the situation will need to get worse in Germany before the budgetary taps are opened. And while, on balance, we expect the ECB to be generous—announcing a cut in the deposit rate, a new asset-purchase programme and strong forward guidance —there is the risk markets are now expecting too much. We therefore remain underweight European government bonds.