September is a month of big choices

Today’s TextileFuture edition is a dedicated analysis of Europe and the elections to be held. It is based upon an excerpt of J. Safra Sarasin Bank and its Chief Economist Dr Karsten Junius, Dr Claudio Wewel and Wolf von Rotberg Equity Strategist. We find these conclusions crystal clear, particularly because after 16 years the German elections will have to find a suitable successor of Chancellor Angela Merkel.

The feature continues with an insight of the Euro Area development of the fixed income by Alex Rohner, Fixed Income Specialist of the Bank. At the same, you will learn what the European Central Bank is planning and the effect it will have.

Last, but not least, the item gives you also an oversight on the actual and future development U.S. equities written by Wolf von Rotberg, Equity strategist of the Bank. You get in addition an impression of the US economic conditions.

September is a month of big choices

At their respective meetings in September, central banks will re-take the centre stage in September. Despite a moderation  in the economic  pace as of late,  we expect  above potential growth and increasing  underlying inflationary  pressures  in the US, which could lead the Fed to already announce its decision to start tapering asset purchases in September.

The ECB on the other hand is still further away from the start of a removal of monetary accommodati on.  Given  that  underlying  inflationary   pressures  are  still  relatively  low in the euro area, the ECB will continue to keep financing conditions loose in order to achieve its symmetric  inflation  target of 2 %. Changes in the  pace of asset  purchases in coming quarters should therefore be interpreted as a re-calibration rather than a taper of purchases.

September is a month of big choices

Politics  will take centre-stage in Germany  with Federal elections  on September  26, 2021 which will likely bring an end to the Grand Coalition of CDU/CSU and SPD. While the final election results remain entirely open, the parties on the political left are likely to be more strongly represented in the next Bundestag.  In our view, this increases the odds of more government spending on infrastructure  and the green transition of the economy  along with further fiscal integration in the Euro Area. Both should support the Euro.

German Federal Election – Election outcome remains entirely open

  • As of late, the g ap between CDU/CSU and SPD has virtually eroded
  • While the Christian Democrats’ victory in the election was considered a given, a combination of factors took their toll on the party’s recent poll ratings.
  • A shift of electoral support from the CDU/CSU to the Greens would bring substantial change to the German legislative landscape.

The  latest Forsa poll  shows the  Social  Democrats  ahead of the Christian  Democrats, and, hence could mark an important turning point for the 2021 German federal election. While the final  election results remain  entirely  open,  the  parties on the  political left  are likely to be more strongly  represented in the next Bundestag. In our view, this increases the odds of higher government spending along with further fiscal integration in the Euro Area. This should support the Euro.

The latest  polls could  mark an important  turning  point in Germany’s  federal election,  which is to be held on September 26 this year. According to the latest Forsa poll published  on Tuesday, Germany’s  Social  Democratic  Party  (SPD)  has  overtaken  the  Christian  Democratic Party  (CDU/CSU)  for the first  time.  With 23 %, the SPD achieved  its highest  poll rating in 15 years, whereas the CDU/CSU’s 22 % represents the lowest score  on the poll’s record. While individual polls always need to be taken with a pinch of salt, the SPD’s rising  mo- mentum is also becoming clearly visible across all other major polls (Exhibit 1).

The  Christian  Democrats’ victory  in the 2021 federal election  was considered  more or less a given at the beginning of the year. Yet various factors have contributed to the decline in electoral support ever since. Throughout the first quarter, mounting frustration over a slow vaccination  rollout along with lengthy  disputes  over the selection  of the party’s front running candidate Mr Laschet have had a visible toll on the party’s poll ratings. More recently, criticism has flared up over his crisis management amid the historic  flooding  that hit the federal state of North Rhine-Westphalia (Mr Laschet’s political home) in July.

If the final electoral results pan out in the way polls currently indicate, the  contemporaneous balance of power between the parties should shift substantially to the left (Exhibits 2- 3). Most importantly, it has become a clear possibility  that  the SPD emerges  as the strongest party, which would substantially impact the probabilities for a possible future coalition. Given the coalitions in Germany’s state  parliaments, the six constellations displayed in Exhibit 4 appear the most likely to us.  Depending on whether the CDU/CSU  or the  SPD turns out as the strongest political force, we think that either a coalition between the CDU/CSU, the Greens, and the liberal FDP (Scenario   1) or a coalition between the SPD, the Greens and the SPD  (Scenario  2) will be the  most probable outcomes. Long-believed to be the most likely result, the odds for a coalition between the CDU/CSU and the Greens (Scenario  3) have declined significantly, as it will make be very difficult  for this constellation to achieve an absolute majority in the German parliament. Though considered rather unpopular, a coalition between the SPD, the Greens and the Left (Scenario 4) could become reality should negotiations with the FDP – which likely represents both parties’ preferred partner in a coalition – fail. Yet, given that a coalition between the SPD and the Left has been in place in the Berlin state parliament for many years, the latter also remains a clear option. Lastly, Scenarios  5 and 6 both involve the former Grand Coalition between the  CDU/CSU and the SPD, and, hence  would be equally unpopular among  voters, as well as the parties’ members. In consequence, the last two scenarios would represent last resort options, in our view.

The election should yield a higher representation of leftist parties in the Bundestag

While the final election result remains entirely open, the latest  dynamics  in the  poll rating s suggest that leftist parties will likely increase their number of seats  in the  German parliament. Hence, most of the coalitional options presented above feature a substanti ally higher representation of the left political spectrum, which  will have  important  implications for the economic policy outlook of the next four years.

SPD and the Greens would probably favour higher fiscal spending  to improve Germany’s ai ling infrastructure and to facilitate the green transition of the economy .

CDU/CSU and FDP are likely to put more emphasis on a balanced budget.

First, the SPD and the Greens tend to favour larger-scale infrastructure spending  programmes, in particular to facilitate the green transition of the economy, while the CDU/CSU and the FDP advocate for a quick re-application of the constitutional  debt brake. The debt break limits structural deficits to 0.35 % of GDP, but makes exceptions for cases of severe recessions and natural catastrophes as the COVID-pandemic would be one. Moreover, the CDU/CSU  and the  FDP  put more emphasis on the 60 % debt-to-GDP ratio as enshrined in the Maastricht Treaty, whereas the SPD and the Greens have remained vague on their contemplated future debt levels. Second, the political parties vary substantially in how far they intend to bring forward further economic integration within the Euro Area. More generally, an increased representation  of the  left-wing  parties  in the  German  parliament  is likely to accept higher fiscal spending at the European level. This could also  lead to  an increased likelihood of future Eurobond financing.

What would a leftist policy mix mean for the Euro?

Clearly, it is difficult to have a strong conviction on how a more leftist  policy mix impacts the European common currency’s exchange rate dynamics.  Additionally, the fact that An gela Merkel emerged as the winner in the past four federal elections makes an expedient evaluation of historical  evidence  even harder. Nonetheless,  Gerhard  Schröder’s  victory  in the  2002 federal  election  represents  the  only  available  showcase since the introduction of the  Euro, in the aftermath of which the currency  trended substantially  higher (Exhibit 5). So if history is any guide, the euro could benefit at the onset of a SPD-led government.

Leftist tilt in federal politics should increase public spending and strengthen European integration, both of which should support the Euro.

Some additional considerations also suggest that a leftist tilt in the federal political land- scape could turn out Euro-positive. Along with creating upward pressure on German Bund yields, the propensity to increase debt-financed government spending  should  boost economic growth and hence may revive inward equity portfolio flows,  which so far have remained below their pre-COVID levels.  Moreover, a higher degree  of European integration should catalyse further economic convergence. This should  keep peripheral yield spreads in the Euro Area low which would support the Euro. In spite of the many uncertainties pertaining to the eventual formation of the next government coalition,  we consequently  think that the likely (more leftist) policy mix should create a rather benign environment for the European common currency.

Euro area Fixed Income

ECB – calibrating, but not yet tapering asset purchases.

September will mark the month where central banks re -take centre stage. While most central banks will convey the message that monetary support will be reduced, the ECB is probably furthest away from any meaningful  withdrawal of monetary accommodation. Consequently, the ECB’s main focal point over the next quarters will not yet be about tapering asset purchases, as is frequently reported, but about calibrating asset purchase volumes such that financing conditions remain loose. Consequently, we believe that Euro Area (EA) inflation expectations have more upside over coming months, and we expect some of the recent flattening in Euro Area yield curves to be reversed.

After a relatively quiet summer period, characterised by lower bond yields, September will mark the month, where central banks re-take centre stage. Their broad message will be that monetary support will be reduced; however, they will act on different timelines. While the Fed will likely embark on a path to taper asset purchases (with other central banks in the Dollar markets potentially hiking interest rates), the ECB is probably the central bank that is furthest away from any meaningful withdrawal of monetary support.

In July 2021, the ECB announced the introduction of its symmetric inflation target of 2 %, which does not explicitly target an inflation overshoot, but would tolerate a period of above target inflation rates. Although Euro Area (EA) market-based inflation expectations have recovered strongly since the onset of the COVID pandemic, they are still substantially below the ECB’s target. Consequently, the ECB has strengthened its forward guidance for policy rates, with a clear commitment to maintaining a persistently accommodative monetary policy stance, i.e., favourable financing conditions, until the objective is reached. Even by the ECB’s own staff projections, the target is not expected to be reached for several years. The conclusion is therefore that the ECB will provide ample monetary support for an extended period of time. In fact, we expect real tapering of asset purchases not before March 2023 and ECB policy rates to remain at current levels at least until September 2024.

Financing conditions are very favourable in the Euro Area

Financing conditions are currently very favourable for the Euro Area. Real long-term government bond yields, as measured by German inflation linked government bonds, are at all-time lows, while credit spreads in peripheral Europe, as well as corporate spreads are stable at low levels, thus facilitating a smooth transmission of monetary policy throughout the Euro Area (Exhibits 1, 2, 3). The objective of the ECB will be to maintain financing conditions that way.

This will be achieved by continued explicit forward guidance regarding the level of policy rates, attractive Targeted Loan Refinancing Operations (TLTROs) and a continuation of the substantial asset purchases to keep nominal rates low and peripheral spreads at tight levels.

It is not yet about tapering, but about calibrating asset purchases to maintain favourable financing conditions.

Consequently, the main focal point over the next quarters will not yet be about tapering asse t purchases, as is frequently reported, but about calibrating asset purchase volumes such that financing conditions remain loose. This will primarily concern the potential transition from the current Pandemic Emergency Purchase  Programme (PEPP), which is due to end in March  2022 at the earliest, to the original Public Sector Purchase Programme (PSPP) or to an alternative set-up.  While PEPP  has contributed substantially  during the pandemic, the PSPP has so far only played a secondary role (Exhibits 4, 5). Whatever the new set-up will look like, the ECB will ensure that the purchase volumes will be large enough to accomplish its objectives for as long as it deems necessary.

Expect a re-steepening of Euro Area yield curves

Unlike the Fed, the ECB aims to maintain current loose financial conditions as underlying euro area inflation pressures are still low and there is little observable wage pressure on the horizon. With policy rates expected to remain at current low levels, euro area real yields will likely stay close to record lows for quite some time (Exhibit 6). Consequently,  inflation expectations  have more upside potential  over  coming  months,  and we would expect  some of the recent flattening in euro area yield curves to be reversed (Exhibit 7).

US Macro – Delta impact on consumer behaviour appears limited

By guest author Raphael Olszyna-Marzys, International Economist at the Bank

  • Many timely indicators of economic growth have softened in recent weeks, but we are not overly concerned.
  • The drop in daily passengers at US airports has more to do with the end of the holiday season than arise in COVID infection.
  • The ‘ Delta wave’ doesn’t seem to have had a large impact on spending at bars and restaurants

The rise in COVID cases across the world has led to  further  disruptions to manufacturing  production. But we doubt that  the new wave of  infections in the US has a large impact on consumer behaviour. Rather, the softening in spending reflects  a normalisation after surging in the first half of the  year. A restocking of depleted inventories is likely to replace consumption as the main driver of GDP growth in the quarters ahead.

The rise in COVID-19 cases in the US, the drop in timely indicators such as bookings at restaurants or passengers passing through airports, as well as the sharp fall in the August Michigan consumer confidence survey, have raised concerns  about  the US economic  out- look. While we shouldn’t dismiss these signals, we are not overly  concerned,  for  three reasons:

First, real-time economic data need to be treated with caution. For one, these indicato rs are not seasonally  adjusted.  True, daily travellers  at US airports have fallen. But this probably reflects, to a large extent, the end of the holiday season  rather  than  any significant impact from COVID cases  on travel  intentions.  Indeed,  the drop in passengers  in recent weeks has roughly followed the same path as in 2019 prior to the pandemic (Exhibit 1).

According to OpenTable, visits to restaurants have dropped  a bit in July and August,  com- pared to the  same  months  in 2019, possibly  reflecting  the  rise in COVID cases (Exhibit  2). Yet,  the  numbers  are only  marginally lower than they were in June when daily new cases were very low. We have looked at restaurant  bookings by state  and  the  associated  evolution of cases since the start of ‘Delta  wave’. While we have found a small  negative correlation between the acceleration in weekly cases and changes in weekly bookings at restaurants, the results are from conclusive, with an R-square of less than 1 %. In addition, restaurant booking numbers are saying  nothing  about  whether  consumers  are spending more or less on their meals and drinks. In fact, while visits  to restaurants  were about  5 % lower in July 2021 compared to 2019, spending in bars  and  restaurants  was about  10 % higher, according to the latest retail sales report.

A strong labour market should keep consumer confidence elevated

Second, household balance sheets are in a good shape and the labour market is set to strengthen further  over the coming  18 months, while headline  inflation should drop from its peak (though the speed at which inflation will fall remains very uncertain), boosting labour real income. A back-of-the -envelope  calculation  suggests  that if the labour mark et gets back to maximum employment by the end of next year, employment could grow by an additional 5 % in 2022. And  if wages pick  up by  4 %, this  would boost  nominal labour income by 9 %, or a boost to real income of 6.5 %, if we assume  a 2.5 % inflation  rate. Historically, the pace  of consumption  and  consumer  confidence have tended  to track  real in- come growth (Exhibit  3). This is a long-winded  way of saying that we expect  the big drop in the University  of Michigan  consumer  confidence   index earlier  this month  to reverse over the coming months. In fact,  the Bloomberg  consumer  comfort  index  has already  been ris- ing over the past several weeks.

… with restocking of depleted inventories becoming the main driver of GDP growth

It is unavoidable, however, that the contribution of consumer spending to GDP growth will drop significantly  in the second half of the year. Spending grew at an annualised rate of about 11% in both the first and second  quarters,  in large part fuelled  by huge fiscal  transfers. Spending on goods is 16 % higher now than it was before the pandemic  (though  the level of spending on services  has  still  not  fully  recovered). With no cheques coming through the post from the government, consumer spending  is likely to grow at a lower but still sustained pace of 3 % to 4 % in the third and fourth quarters.

Finally,  supply-side bottlenecks, combined with very strong demand have led companies to deplete  their inventory stocks. Restocking of inventories should  contribute significantly to growth in the second half of the year. According to the latest ISM survey (Exhibit 4), producers’ assessment of the  level of inventories  of their customers has never been so low – or a least since the start of the series in 1997. While supply-side constraints could frustrate corporates’ ability to reconstitute their stocks, the Atlanta Fed estimates that re-stocking will add 3.6 % percentage points to GDP growth in the third quarter.

GDP growth should remain elevated in the second half of the year

In short,  a moderation in the pace of consumer spending in the second half of the year was always  on  the cards after a very  strong  surge in the  first half of the year. We don’t think that the resurgence in COVID cases has too much of an impact on consumer behaviour. Looking to the end of the year, a strong restocking of depleted  inventories  should become the main driver of GDP growth.

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