10Y dollar emerging markets S&P 500

“Do You See What Happens?!” One Bank Explains The “Implications” Of Failure Friday

"What are the asset pricing implications of what happened on Friday?"

If you’ve been following along over the past several days, you already know how things are likely to go this week.

And if you needed some kind of confirmation for what you already knew, all you have to do – as we noted earlier this morning – is look at the dollar. Here’s what we said:

Well, the dollar is under pressure on Monday, just as we said it would be on Sunday evening.

The Bloomberg Dollar Spot Index fell as traders digested the failure of the GOP health care bill on Friday. This is the index’s eighth drop in the last nine days, and as Bloomberg notes this morning, “further losses of just 1.4 percent would mean the gauge will fully erase its gains since Donald Trump won the U.S. elections.” In addition to position-squaring, traders are seeing “fresh selling pressure, mainly by hedge funds.”

Right. You get the idea.

So that’s the catalyst. And as we’ve expounded more times than we expected already on Monday morning, the implications are clear. But in case they aren’t, here’s BofAML to explain.

Via BofAML

What are the asset pricing implications of what happened on Friday? In our view, the immediate reaction should be lower equity prices, a rally in bonds, a weaker USD and a rally in EM, on the premise that the outlook for expansionary fiscal policy becomes more blurry. Along those lines, given the heterogeneous re-pricing observed so far, equity markets and inflation breakevens are relatively more exposed. Regarding EM, even though the Friday’s outcome is in theory favorable for the usual EM carry trades, a significant risk-off scenario (not our baseline) would trigger risk exposure reduction that could push EM lower.

Even though it is far from obvious that the issues at stake on the Health Care reform are good predictors of the negotiations that will soon start for the tax reform, uncertainty remains high. In favor of Trump trades, it is fair to say that the massive asymmetry in the risk-reward has been removed. Long USD positioning has been balanced and EM has experienced 13 consecutive weeks on inflows which removed a fair amount of risk premium. In addition, political uncertainty coming from Europe with upcoming elections in France and Germany is far from easing in the short term.

Against Trump trades, relative monetary policy is not helping the USD, as the market is pricing in more hawkishness in Europe relative to the US, and the outlook for fiscal policy does not look any better than a few weeks ago. The tug of war is therefore between positioning and fundamentals. Positioning alone will not do the trick; the trigger needs to come from fundamentals, in our view.

Or, to paraphrase The Big Lebowski, “do you see what happens Larry?! Do you see what happens when you rush comprehensive health care reform?!!”


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