Despite initial misgivings about the election of Donald Trump markets have voted with their positions in favor of the administration to be.
Equites and the dollar are substantially higher. Commodities are moderately lower. Bond prices are down significantly and yields higher, resuming their historical counter-cyclical attitude to equities.
The 10-year generic Treasury yield closed at 2.3026 on Thursday, up 8 basis point on the day and 52 points since November 4th. This is the highest close this year and the steepest ascent since the ‘taper tantrum’ in the summer of 2013. The 2-year yield closed at 1.0461, the highest since December 30th, 2015. Gold is down 6.8 percent since November 4th.
All of these reactions are what you would expect from markets pricing for stronger economic growth. Is this realistic or simply an adjustment to being so egregiously ill-positioned in anticipating the election outcome?
First to remember is that markets are not politics. Markets are discounting the end of election uncertainty, an improvement in U.S. economic growth and a potential quickening of interest rate normalization not social or cultural decisions.
Equites traders see a more business friendly administration beginning on January 20th with tax cuts for business and individuals, general deregulation, a pullback or repeal of Obamacare and a large burst of fiscal stimulus as the most likely economic policies.
A December Fed Funds hike is a near certainty, the futures have it at 96 percent. Over the past week the dollar is stronger against all the majors except the British Pound, which is flat. Emerging markets currencies are uniformly weaker with the Mexican Peso at an all-time low and the JP Morgan Emerging Market Currency Index down 3.5 percent from its close on November 4th. The mild fall the Bloomberg Commodity Index is likely the result of the stronger dollar on pricing and not yet a judgement on the better prospect for U.S. led global economic growth.
Whatever policies are enacted by the Trump administration their effect on the American economy will take time, and the positive (or negative) results will not appear in the statistics for many months. The immediate question is Fed policy. Implied probabilities for rate hikes have moved higher with the chance of a second hike by the June meeting at 40.6 percent and for two hikes by the end of 2017 at 43 percent.
Mr. Trump’s election as head of a unified government means that Fed monetary policy will no longer have to bear the entire weight of economic growth. With fiscal and legislative policy under party control the FOMC will have greater leeway to end its experiment with zero rates. Normalizing interest rates will benefit the economy by restoring the ability of business to plan across several years. But even assuming the Fed raises rates at the December meeting the likelihood of multiple hikes in 2017 is, at the moment, uncertain.
Two factors will work against an appreciably faster Fed rate cycle. First, as the Republicans try to foster economic growth the last thing they will want is the drag of higher interest rates and that will reinforce the Fed's natural caution. The central bank may be reasonably insulated from political pressure, Ms Yellen has said she will finish her term as Chair and the Trump campaign has said she will not be asked to resign. But with the economy moving into its eighth year of a weak recovery and myriad economic problems and political currents swirling around the globe, it is not at all clear that the American economy will improve enough to permit the Fed to exercise its wish for higher interest rates.
Even if the Fed does persist in normalizing interest rates, central banks in the United Kingdom, Europe, Japan and China are not likely to follow suit. The increasing disconnect between U.S. rate policy and the rest of the world could act as a brake on the American economy through a higher dollar. The 3.1 percent devaluation of the Chinese Yuan against the dollar since October 1st can be seen equally as a sign of impending trouble in the mainland economy and a warning to the U.S. on trade policy.
A likely first priority for the Trump administration will be improving U.S. economic growth and wages. The probable conflict between that desire and Fed policy has not entered into market calculation yet, but as the incoming administration completes its appointments, it must.
The movement we have seen in all markets since the election is most likely a repricing of a mistake not a true judgment on the possibility for improved economic conditions in the U.S and around the world.
Chief Market Strategist
WorldWideMarkets Online Trading