Weekly Focus – Democratic Clean Sweep

With victory in the two special Senate runoffs the US Democratic Party has achieved a clean sweep and will control the presidency and both chambers of Congress. While it is a narrow victory, as Vice President-elect Kamala Harris will cast tiebreaking votes in the 50-50 Senate and the Democratic Party lost seats in the House in November, history tells us that it is much easier to get things done when one party controls everything – Democrats and Republicans have had difficulties cooperating for at least 30 years. The expectation of an expansionary stimulus package from the Biden administration prevails in markets. The riots at the Capitol building did not leave a mark on markets. The expected additional fiscal stimulus has sent US rates and inflation expectations notably higher. The 10y break-even inflation expectation has risen 10bp to 2.09% this week. This has also driven the EUR inflation expectations higher, but we need to see a significant catalyst to bring inflation expectations above pre-COVID-19 levels (around 1.3%). The HICP flash release in the euro area was still in negative territory of -0.3% in December (core at 0.2%).

As regards COVID-19, the situation in Europe continues to be serious, with the new more contagious variant of the coronavirus, first found in the UK, spreading to most countries. The UK and Ireland have seen a sharp resurgence in the virus and are experiencing high pressure on hospitals. It is still too early to judge the full effect of Christmas and New Year, as test levels have come down. Several countries have expanded and extended restrictions to last throughout January. In the US, hospitalisations continue to climb higher and many places have already reached or exceeded capacity, so we would not be surprised if we see a further tightening of restrictions, see more in COVID-19 Update – EU gets more vaccine ammunition with approval of Moderna after slow start, 7 January. European activity data showed a dismal reading for services in southern Europe for December and euro area retail sales in November of -6.1% m/m have also been quite worrisome. On Friday next week, the US retail sales for December will be released. We will monitor to see if another decline from October/November is recorded. Next week, we get the UK GDP figure for November, which we expect to print in negative territory on the back of the lockdowns (October release was 0.4% m/m).

In China, Caixin PMI manufacturing for December declined to 53.0 from 54.9, pulling back from the highest levels in nearly 10 years. The official PMI manufacturing as well as service PMI released last week also moved lower. The numbers fit well with our expectation that China is close to a peak and will slow down to a cruising speed recovery during 2021. This could forestall a peak in PMIs in the US and Europe as well soon.

On the political scene we have an important CDU party convention in Germany on Friday/Saturday where the ruling CDU party will elect a new party leader to replace Merkel. That person may potentially become Chancellor after the September parliamentary election, when Merkel will officially step down. The opinion polls are currently pointing to Friedrich Merz, considered a fiscal hawk. If he is elected that could mean the German fiscal approach reverting to its pre-COVID19 approach.

Full report in PDF.