The month of August tends to be slow and lazy. But investors and politicians are returning from their summer vacations with a long list of issues confronting them in September. Below, I summarize 10 important things to watch this month.
1. North Korea. Geopolitical risk has risen, particularly with increased missile tests and growing tension between North Korea and the U.S., Japan and South Korea. The yield on the Japanese 10-year bond fell below zero last week as investors in the region fled to safe haven assets. And, as of this writing, the yield on the U.S. 10-year Treasury bond hit its lowest level of the year on Sept. 5.1 North Korea recently announced it can fit a hydrogen bomb on an intercontinental ballistic missile, and it is racing to develop nuclear weapons capabilities – a frightening development for the free world. The $64,000 question is whether the U.S. and its allies will be able to kick the can down the road, as has been done for the past 25 or so years, or will they be forced to take action. One issue is that these allies don’t seem to be on the same page when it comes to how to deal with this nuclear threat, which arguably reflects differing levels of geographical proximity to North Korea. Another important question is whether the U.S.’ emphasis on tying trade to this issue – with regard to both China and South Korea – will turn out to be a brilliant move or a mistake. We will watch the situation closely, recognizing that any deterioration will likely be reflected in a further move to safe haven assets such as Japanese government bonds, U.S. Treasuries and gold. I believe it is even possible for the U.S. 10-year Treasury yield to fall below 2% if the situation worsens significantly.
2. Brexit negotiations. The third installment of Brexit negotiations concluded last week with reportedly little accomplished. This is concerning given that the U.K. has only 18 months to accomplish a long and arduous list of tasks: 1) complete the negotiations, including the “divorce bill” and the trade relationship post-Brexit, 2) obtain approval from the European Council, 3) obtain the approval of at least 20 of the 27 member states (with 65% of the population), and 4) bring the agreement to the European Parliament for ratification.
The good news is that the U.K. announced it will intensify talks by meeting more often than just one week a month. Hopefully that will enable significant progress in the coming months, which should keep a lid on investor anxiety.
3. The German general elections. On Sept. 24, Germans will go to the polls to elect the leader of the largest economy in the eurozone. Chancellor Angela Merkel’s party is far in the lead, but it does not have a majority and, as in the past, must form a coalition government. It could do so with the parties it currently has an alliance with, or, depending on the outcome of the elections, a coalition could include the Free Democratic party, a recently revived pro-business party with an interesting agenda at a time when some businesses seem to be getting less positive on the economy. For example, the ZEW Economic Sentiment Survey saw a decline in sentiment from 19.5% in April to 10.0% in August.2 I believe that this party, with its focus on technological innovation and involving business leaders in government, could inject some change and excitement into Germany and its economy if it gains enough traction in the elections.
4. The plans for tapering in Europe. The European Central Bank (ECB) will meet later this week, and one potential topic of discussion is the timeline for tapering its massive bond purchase program. The European economy continues to strengthen, as evidenced by the Citigroup Economic Surprise Index for the eurozone, so it seems likely that tapering will begin by early next year. In the meantime, we could see the euro strengthen, particularly if geopolitical risk increases given the euro’s historical status as a “crisis currency.”
5. French labour reforms. French President Emmanuel Macron last week released his relatively comprehensive plan for labour reform. The plan includes a reduction in regulation around companies’ termination of employees, and a reduction in the increased regulation applied to companies with 50 or more employees. In general, these reforms are intended to be business-friendly and to ultimately encourage more hiring, given that many economists believe companies forego employee hiring whenever possible in France because of all the responsibility and regulation placed on them. But President Macron’s labour reform plan is now subject to government review and change. And then at the end of September, it will be reviewed by the French Constitutional Court. We will follow its progress closely. Business sentiment has improved significantly in the past several months on expectations of what President Macron can accomplish with a parliamentary majority, and the successful implementation of this plan could result in increased business spending.
6. The U.S. Federal Reserve’s September meeting. The September meeting of the Federal Open Market Committee (FOMC) could be a historic one with the possible announcement of balance-sheet normalization. And while not my base case, normalization has the potential to be disruptive to markets, particularly the stock market. What’s less certain than balance sheet normalization is the Fed’s view on when it will raise rates again. Economic growth is strong – gross domestic product (GDP) growth for the second quarter (the second estimate) clocked in at 3%,3 and the Atlanta Fed’s GDPNow Indicator is currently forecasting 3.2% growth in the third quarter.4 However, the U.S. jobs report for August underwhelmed relative to expectations. Payroll growth was solid, which was expected given the maturity of the labour market recovery, but wage growth remains very low, which is surprising given how low unemployment is. We should expect that there will be some debate around wage growth and inflation when the Fed meets. Perhaps most important is that September may bring an announcement or at least some hints about who the new Fed chair will be.
7. U.S. Congress’ daunting legislative to-do list. After talking about this for months, we’re finally getting to the point where the rubber meets the road. Congress returns from summer recess this week and has a packed agenda to tackle, including raising the debt ceiling, agreeing on and approving a budget for the next fiscal year, and approving aid for areas affected by Hurricane Harvey. They will also have to sort out a potential replacement for the Deferred Action for Childhood Arrivals (DACA) program, as well as tackle the enormous task of tax reform. With political divisions seemingly growing, we could see some disorder in Washington, with legislators moving like pinballs from one crisis to the next.
8. NAFTA negotiations continue. The second round of North American Free Trade Agreement (NAFTA) negotiations finishes this week and, as with the third round of the Brexit negotiations, little progress has been made. Republican Senator Ben Sasse of Nebraska argued that the Trump administration is promoting an “18th century” view of trade. It seems that NAFTA may be in more jeopardy than ever before, with President Donald Trump tweeting last week that both Canada and Mexico were being “very difficult” and that the trade agreement should be terminated. We will follow developments closely given the potential impact on the economy.
9. India cabinet reshuffling. Prime Minister Narendra Modi recently made significant changes to his cabinet. Perhaps the most important change was to remove defense duties from Arun Jaitley, who served as both Defense Minister and Finance Minister, which enables Mr. Jaitley to focus on the economy. The changes to the cabinet came in the wake of the release of the Reserve Bank of India’s annual report, which noted that while the Indian economy demonstrated resilience over the past year, GDP growth was impacted by a “slowdown in gross capital formation” caused by “waning business confidence and flagging entrepreneurial energies.” Prime Minister Modi’s key objective in the cabinet restructuring is to achieve higher economic growth and create more jobs. We will want to follow this closely to see if these changes, along with Mr. Modi’s reforms, are able to positively impact the economy.
10. China cryptocurrency ban. Earlier today, Chinese regulators announced a ban on digital currency offerings – also known as initial coin offerings (ICOs). Some have suggested that this is just the start of a broader crackdown on cryptocurrencies, which could mean that other stores of value and “safe haven” asset classes such as gold, the dollar, the euro and the yen could become more popular. We will follow any further developments on this issue given the implications for other asset classes.
As we look ahead to the fall, the potential for market disruption has grown, largely from geopolitical risk but also from monetary policy risk. In this environment, I believe investors will want to be even more focused on protection while still participating in capital appreciation.