US Politics: How the economy performs will be crucial for trade policy – Our base case is that Democrats will take the House, with Republicans retaining the Senate in the elections on 6 November. However, the polling is close enough that both a Democrat clean sweep and Republicans retaining the House and the Senate are plausible risk scenarios come election day. We have laid out our views on the broader macro implications of the midterms in our Three scenarios report. However, one specific question that has cropped up is, what would happen to trade policy in each scenario? The short answer is that a Democrat win would likely lead to a less combative trade policy, with a Republican win making it potentially more combative.
The long answer is more ambiguous, and ‘it depends’. Strictly speaking, Congress has authority over trade policy, in that it must ratify any official agreements, for example NAFTA. But, when tariffs are imposed on the grounds of national security (as with the steel and aluminium tariffs), or in retaliation against intellectual property theft (as with the China tariffs), the president can act without the approval of Congress. So, the outcome of the midterms will not influence trade policy directly, in our view.
Rather, the effects would be more indirect. Ultimately, what will really determine the tolerance and appetite for a trade war is how the US economy responds to tariffs. If the tariffs continue to have no significant growth impact (as we expect), the political pressure against them will be less. If, on the other hand, we start to see some significant hit to confidence, that would change the calculus. Meanwhile, a Republican win scenario makes a prolonged trade war more likely, as strong economic growth is likely to persist in that scenario (because we assume an additional round of fiscal stimulus). On the other hand, a Democrat clean sweep would (probably) loosen Trump’s grip on the Republican Party, and we are likely to see more pushback against his more unpopular policies – of which trade is arguably the biggest. (Bill Diviney)
Global FX: Limited downside in EUR/USD – Over recent weeks, three different drivers have left their mark on EUR/USD. For a start, concerns about the Italian budget target for 2019 and the tensions between Italy and the European Commission and within the Italian government have resulted in a wider 10y government bond spread between Italy and Germany. This has weighed on the euro. Moreover, some dovish Fed officials have sounded more hawkish. This and higher oil prices have resulted in higher 10y US Treasury yields. In turn, the US dollar has received support from this across the board (the yen has been an exception, strengthening on the back of haven demand amid weakness in equity markets). These factors have driven EUR/USD below 1.15, taking out the technical support level at 1.1460. We expect the upside in the US dollar to be limited though. We think that 10y US yields are in the process of peaking and we also expect US growth momentum to peak this year. Our expectation for three further Fed rate hikes are close to being priced in. In short, we doubt the environment can get more supportive for the US dollar. Moreover, we don’t expect that tensions between Italy and European Commission will get completely out of control, resulting in a sharp increase in 10y yield spread between Italy and Germany. All told, we expect EUR/USD to set a bottom above 1.1301, which is the previous low set in August. (Georgette Boele)