Politics and labour market risks

Politics and labour market are key risks for September

Stocks in Europe and Asia had a mixed start to September. The Euro Stoxx index is eking out a small gain, while the FTSE 100 is down 0.11%. For those who have been around long enough, this should be no surprise. September is traditionally a terrible month for markets as investors rebalance their portfolios after the summer break. To put the extent of some September moves into context, it is traditionally a bad month for stocks, bonds and gold. The price of gold has fallen during each September since 2017, and gold is down a touch on Monday. The risks are seen to be particularly high this September due to elevated valuations, the S&P 500 is close to its record high, political risk and the prospect of an interest rate cut later this month.

US labour market could surprise once again

The economic risks hinge on this week’s US Non-Farm payrolls report. The market is expecting a bounce back in job creation in August after the dismal 114k NFP number for July. Weakening payrolls triggered the short sharp sell off in global risk assets at the start of August. It may seem like a distant memory now, but recession fears weighed on sentiment back then. The market has recovered well, the Vix is currently trading around the 15 level, which suggests that the market does not think that a big shock is on the cards for this Friday. However, it is worth remembering that payrolls move the market. Another weak reading could lead to a continuation of the dollar downtrend, the dollar is the weakest currency in the G10 FX space for the past month, and it is down by 3% vs. the pound and 2.3% vs. the euro.

However, the interest rate market is also worth watching closely. There is currently 100bps of Federal Reserve interest rate cuts priced in by the Fed Funds market between now and December. If we get a stronger payroll reading, and an upward revision to last month’s number, this could trigger another sell-off as it may make the Fed less likely to signal future rate cuts, although a rate cut later this month is a near certainty. If we see a pricing out of interest rate cuts in the aftermath of this week’s payrolls report, we may see a strengthening of the dollar, which could be bad for risk sentiment.

Wage growth shows signs of coming back

It is also worth watching wage growth in the US payrolls report this Friday. In the UK, Reed, a recruiting firm, noted that in the three months to July, wage growth rose in sectors that demand in-person attendance, such as construction, engineering and education. Official wage growth figures have been slipping in the UK in recent months, and wage growth recently fell to its lowest level since early 2021. However, trends could be shifting once more, and this may also show up in the US data, that could complicate the future path for the Fed, the BOE and other central banks. Thus, traders should not bank on sustained rate cuts propping up markets.

US election risks rise as debate nears

The other risk that seems to be underpriced right now is political. Although there are political shocks happening all over the world, the biggest risk is still the US election in November. However, ahead of that is the first presidential debate between Kamala Harris and Donald Trump that is scheduled for Tuesday September 10^th. Ahead of this debate, US Predictit polls have 55% of the public supporting Kamala Harris and 48% supporting Donald Trump. Momentum seems to be on Harris and the Democrats’ side; however, Harris has not been keen on interviews, and has not appeared in a full-length interview on her own since she announced her campaign. Thus, this debate could be pivotal to the momentum of both campaigns.

If Kamala Harris can win in November, it is worth noting that the markets tend to perform best if there is a split in government: the White House is governed by one party, and Congress is governed by another. Markets do not react well to one party in control of both Congress and the White House. Thus, the presidential debate is not the only election race to watch in the US this autumn.

Adding to the political risks, is the prospect of a contested election result, like in 2020 or a disorderly transfer of power from one President to the next. Either event could trigger volatility in the aftermath of the election, however, at this stage it is too hard to predict if either of these situations will come to light.

Germany: where economic and political risks collide

Germany is experiencing political turmoil after the public in two states in Eastern Germany voted in the far right AfD party. This is a clear sign that some voters are angry and unhappy with the political mainstream. However, two states will not determine who governs Germany, and it could act as a wakeup call. The UK and the US have dealt with this in recent years, but this is new for Germany. It also comes at a delicate time for Europe’s largest economy, which is struggling. The German economy has contracted in two of the last three quarters, and the German manufacturing PMI report for August only rose slightly to 42.4, which is still deep in contraction territory.

On Monday, Volkswagen, one of Germany’s largest companies, announced that it would cut costs and it may have to close factories in Germany for the first time. The company is trying to end the pact with unions that would have protected jobs by 2029. This could add to economic pressure, dent confidence, increase unemployment and add to the pressure on Olaf Scholtz’s government. The market reaction has been mild so far, but it could dent sentiment towards German stocks. The Dax reached a record high last week, however, the mid cap Dax, the MDax, could see its recovery stall after struggling for most of the summer.

The market impact

Overall, from a market perspective, the reaction to next week’s US Presidential debate could set the tone for how markets react to the election risks ahead and whether September will be a dismal month for asset prices. For example, could gold shun its historic dismal performance this month, especially if the Fed cuts rates as inflation risks remain, and if political risks look elevated? Also, can US stock indices remain close to record high levels if political risks merge with a less dovish Fed? This could also knock the broadening out of the rally, and the performance of the Dow Jones, as investors flock to bigger companies with solid balance sheets, like tech. This is one of the main reasons why we urge caution when it comes to calling the end of the AI and tech stock rally.