Von der Leyen versus Trump

EU: read the speech!

With the round of top nominations in the EU now largely behind us, it is time to focus on the policy substance. To win her wafer-thin majority (9 votes) and get confirmed as head of the European Commission, Ursula von der Leyen could have reached out to the right – especially the Eastern European right – or to the left-leaning and Green MEPs. Judging by her speech ahead of the vote, she clearly chose the latter. We think it matters because it is another reason to expect an even more conflictual relationship between the EU and Donald Trump’s United States.

First, she explicitly supported the French move towards taxing the the large global digital companies). Her words were strong: “it is not acceptable that they make profits, but they are barely paying any taxes because they play our tax system”. She was more granular in the extensive “political guidelines” document published alongside her speech, mentioning that “discussions to find an international solution are ongoing…however, if by the end of 2020 there is still no global solution for a fair digital tax, the EU should act alone”. The message to the US is clear.

Ultimately, it is a logical move from the EU to preserve its social model while upholding free trade. Indeed, if taxation cannot reach the most mobile beneficiaries of globalisation, the cost of funding the welfare state will fall on the least mobile sources of income, and workers in the first place. At least symbolically, taxing the GAFAs is a way for the European institutions to demonstrate to the electorate that the populist message is heard.

Second, she pledged to introduce a “carbon border tax”. This idea – which has been pushed by France for a decade – would operate as a trade tariff levied on imports from countries where carbon emission is not sufficiently curbed. This would address the “carbon leakage” issue: the most advanced countries could make their r own output carbon-neutral  while still contributing to worldwide emissions by importing from less CO2-lean countries. In principle it should be compliant with the rules of the World Trade Organisation – which explicitly provides space for measures “relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restriction on domestic production”.

The practical difficulties are very significant – the absence of a recognized benchmark for the carbon footprint of products being one of them. But the political message is unlikely to be missed in Washington DC. Such an option had been frequently debated when the US decided to withdraw from the Paris agreement.

All this makes the ongoing trade negotiations with the US more difficult. Interestingly, there was nothing granular on this subject in the speech or in the “political guidelines”. She simply stated that “We will work to strengthen a balanced and mutually beneficial trading partnership with the United States”. The clock is ticking. The US tariff reprieve on imports from the EU expires at the end of October.

While there is obviously a will, the way is more elusive. Von der Leyen’s very small majority in parliament is in itself an illustration of the difficulties facing any policy – especially any new policy – going through the EU institutions. For years decision-making has moved away from the Commission towards the European Council, and it’s unclear if the required majorities – and sometimes unanimity – would be found in this forum to advance the ambitions contained in the “political guidelines”. Von der Leyen with her speech has not made many friends in the Eastern member states, nor probably in Rome. Still, we find it striking that the new policy course is almost exactly the opposite of the populist, euro-sceptic stance most market observers were fearing ahead of the European elections.

UK: parliamentary rebellion is still not enough

The winner of the current leadership race in the Tory party – and normally next Prime minister - will be known on July 23rd, with Boris Johnson still the favourite. What has changed this week though is the clearer sense of rebellion in parliament against “sleepwalking into a no-deal”.

“No deal” is what would happen by “automatic operation of the law” on October 31st if nothing changes. What is still putting a – very low - floor under Sterling is the belief that “something will change”, probably through parliamentary action, before this deadline. “No deal” has increasingly become the preferred outcome of the “hard Brexiteers”. Such an approach had not been ruled out by Boris Johnson, even if he suggested the probability of such an outcome to be “one million to one”.

To achieve this, one  course of action would simply be to not summon Parliament in the run-up to the deadline. This approach has been made much more difficult on Thursday 18 July, with the Commons supporting an amendment which requires Parliament to meet regularly  between 9 October and 18 December (effectively de facto preventing suspension).  The majority (41) was convincing, and crucially 4 cabinet ministers, including the Chancellor of the Exchequer Philip Hammond, abstained while 17 Tory MPs rebelled.

The issue though is that parliament cannot force a decision on Brexit. Technically, to avoid a “no deal” Brexit parliament has only two options left: either accept a deal – but the only one on the table has repeatedly failed to find a majority – or instruct the Prime Minister to request another extension. Ursula von der Leyen has indicated that she would support such extension “if there are good reasons”.  The Council may also be more demanding than in April, since the current 6 months extension did not yield any tangible results. General elections may well have to be on the table.

The parliamentary rebellion in itself does not bring any resolution. We’ve been of the view that any resolution was next to impossible without first general elections bringing in a new majority, either for a deal, no deal or another referendum. This is why touching British assets at the moment is so difficult: even in case of a favourable outcome (e.g. a new referendum) the country will first need to go through even more uncertainty. Given the state of the polls, with for the first time 4 political forces polling between 15% and 30%, and the British “first past the post” electoral system, political predictions are next to impossible. 

Eternal Draghi on the ECB’s mind

The ECB’s Governing Council is meeting on 25 July amid mounting market expectations. In Sintra the September meeting had become “live” but now we find an increasing proportion of investors and analysts expecting some action next week already, in particular a rate cut.

We are not convinced. It is true that Draghi sometimes plays the market to create a fait accompli situation forcing the council eventually to act for fear of triggering a nasty “disappointment trade”. Still, it may be obvious but at the last meeting the ECB’s forward guidance still made clear the council expected policy rates to stay “at their present levels” at least through the first half of 2020. To “expect” is not a commitment but for us it would be odd to cut before changing the forward guidance to include an “or lower” caveat on the rate level. This is actually what we expect the ECB to do next week: telegraph a rate cut – mitigated by tiering – but no actual move (we expect it for September).

On QE, we’ve addressed several times already in Macrocast why in our view the bar for QE is higher than what the market is pricing and coming after Coeure’s cautious speech last week we found Villeroy de Galhau’s statement on the ECB following data and not market expectations quite telling.

The risk then is that the ECB disappoints on Thursday. A way to avoid such disappointment would be for Draghi to distract attention from the lack of actual decisions with the announcement of a “review” to make the ECB’s target symmetric, in clear to drop the notion inflation should be “below” 2% in the medium run to keep only the condition it should be “close” to 2%.

This would send a dovish message to the market but we think fundamentally that it would be a fairly empty statement without clarity on the toolbox. Indeed, in itself such a change would mean the central bank would be more patient and more easily tolerate some overshooting. This would make the curve flatter (although one may wonder how much flatter it can go…), but the credibility issue for the ECB actually pertains to its capacity to deliver on its current target definition. What investors want to know ultimately is how easily the self-imposed limits to QE in particular can be disposed of, and we don’t think we will have the answer to this next week.

Draghi is protecting his successor, not tying her hands.  It is a question we get asked a lot. Is Draghi’s scramble to re-open the doors to many policy options and potentially change the target a way to impose his legacy to his successor? We don’t see it that way. In our view, Draghi is trying to take as much personal responsibility as possible for potentially controversial decisions Lagarde may have to make, so that any political fallout would be on him, preserving her own political capital. This means in our view that options need to be prepared and openly debated. Not that they necessarily have to be executed under Draghi’s leadership.

This communication is intended for professional adviser use only and should not be relied upon by retail clients. Circulation must be restricted accordingly.

Issued by AXA Investment Managers UK Limited which is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No: 01431068 Registered Office is 7 Newgate Street, London, EC1A 7NX. A member of the Investment Management Association. Telephone calls may be recorded or monitored for quality.

Information relating to investments may have been based on research and analysis undertaken or procured by AXA Investment Managers UK Limited for its own purposes and may have been made available to other members of the AXA Investment Managers Group who in turn may have acted upon it. This material should not be regarded as an offer, solicitation, invitation or recommendation to subscribe for any AXA investment service or product and is provided to you for information purposes only. The views expressed do not constitute investment advice and do not necessarily represent the views of any company within the AXA Investment Managers Group and may be subject to change without notice. No representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein.

Past performance is not a guide to future performance. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested. Changes in exchange rates will affect the value of investments made overseas. Investments in newer markets and smaller companies offer the possibility of higher returns but may also involve a higher degree of risk.