The mid-term voting is to determine the members of the two chambers of Congress, which is responsible for passing US laws. Both chambers are currently controlled by the Republicans but there is a real possibility that the Democrats could win a majority in one of the chambers, thus being able to block any bills that Trump wants to pass into law.
As well as halting unproductive policies such as the US-Mexico wall, a Democratic majority could cause gridlock for economy-boosting measures such as infrastructure spending. The US economy is well into its second-longest growth phase since World War II and the consensus is saying recession will arrive in late 2020. Could the midterms be the roadblock that sends the US on the path to recession? We think not.
Inflation in ‘Goldilocks’ territory
Inflationary pressures are increasing in the US but at a modest pace. Declining union power and increasing corporate concentration are limiting wage pressures. The growing role of ‘intangibles’, such as brands and software technologies, means that many firms can rapidly increase supply in response to strong demand without putting pressure on inflation. Some of the most successful companies in the world don’t use much conventional capital and often don’t actually produce anything physical. If you consider Facebook, for example, their profitability is based on the intellectual property that drives their networking technology. As ‘intangibles’ grab a growing proportion of the US, and indeed the global, economy, their almost infinite scalability should drive even longer growth cycles.
The spectre of deflation has all but disappeared from the world economy. Although inflation is rising in the advanced economies, pressures in the US are under control – not too hot and not too cold. The US Federal Reserve is ahead of the game and looks set to avoid the sort of policy mistake that could precipitate a recession.
How big is the trade war threat?
On the other hand, should the mid-terms provide a gateway for Trump, will certain measures, such as an escalation of trade wars, have an adverse effect? Again, we think not. Trade wars will likely have a limited impact on the world economy, with Chinese companies look set to be the most affected. However, their exports to the US are a small and declining share of the Chinese economy and will be diverted, at least in part, to other markets, especially if the 25% tariffs (due in January 2019) go ahead. Indeed, reduced US demand for imports from China is
more likely to benefit other foreign countries rather than US domestic producers.
Equities still rule the roost
In terms of global asset classes, benign inflation and a robust world economy point to a positive environment for risk assets. Equities should generate reasonable returns, albeit limited by rising interest rates and subject to bouts of volatility. We are neutral on emerging market equities overall but are overweight countries ex-China. Government bonds are likely to suffer as central banks, led by the US, move gradually to normalise interest rates and reduce their balance sheets. We expect fixed income in general to underperform. Corporate credit could offer
the worst of both worlds: we think credit spreads are too tight and are underweight in both developed and emerging market corporate bonds. In our view, corporate risk is best taken in equities, while credit is inferior to government bonds as a hedge against recession risk.