Trump’s abuse of power and monetary offset
Here in Washington, the city is abuzz over the crisis engulfing the Trump Administration. But politics are less important to markets than one might expect, despite markets being forward-looking. That’s because it’s often hard to judge what impact the politics will have on interest rates and profits.
The negative impact of Trump on the US dollar is palpable, but I see few other signs that markets are sensitive to the political situation. Some thoughts below
The political situation is awful. On the politics, here’s what I’m seeing. Before last night, the Trump-Russia scandal was ‘contained’ because Republicans largely remained loyal to Donald Trump. But the revelation last night of the Comey dinner memo alleging Trump asked Comey to ‘go easy’ on Flynn after he was fired has changed the mood significantly. People who are not Democrats are now talking about abuse of power, obstruction of justice and impeachment. The situation is very serious.
Stalled Agenda. None of the Trump or Republican agenda – on taxes, on healthcare, on NAFTA – is seeing any visible progress. There are only about 40 working days left before Congress’ August recess. From a market perspective, the lack of tax reform is the most important factor. But Trump’s reactions to the Russia investigation are sucking the air out of the room. So the talk about 3 and 4% growth looks like a pipe dream. But was that ever really realistic?
Monetary Offset. If you read the latest analysis from the Brookings Institute’s David Wessel regarding the Fed’s reaction function, it’s clear that the Fed would try to offset all of the so-called pump-priming Trump would try and do. And that’s because we are well into the business cycle, not at its trough.
Market reaction: The markets are on their own then. And with valuations in equities stretched – and no boost from fiscal policy due to a stalled agenda and monetary offset – gains are more difficult. On the fixed income side, short US Treasury positions are at their highest levels since 1993. Combine this with a flattening yield curve and it speaks to caution regarding the economy. But this pre-dates Trump’s woes. And in currencies, none of the downward move in the Dollar index has come in the last couple of months.
Source: Holger Zschaepitz
Bottom line: The politics in Washington – as troubling as they are – seem to be having little real impact on markets… so far. Moreover, the next quarter or couple of quarters will see pretty good economic growth. The Atlanta Fed’s GDPNow figure is back up to 4.1% for this quarter. That’s supportive of equity markets. But markets are on their own afterwards. And the yield curve flattening and short Treasury positions in bond markets tell you traders are cautious.