So there are two things you can do when bad things happen or when the narrative you’ve been clinging to in order to justify your positions falls apart.
You can i) admit that things didn’t go the way you thought they were going to go and trim your positions (which is apparently what a whole lot of 10Y shorts did in the days following the Fed) or you can ii) double down on your mistake and try to find a way to claim you weren’t wrong.
On Tuesday, BofAML is taking option ii to a whole new level.
Now let’s be clear about something: if you’ve been following along with the commentary over the past couple of days it was clear that this kind of thinking was on its way to being crystallized by some enterprising desk or other. It was just a matter of which one would stick their neck out.
That is, this whole idea of “well, ‘repeal and replace’ went really wrong, but on the bright side, that means we can ‘move on’ with tax reform” backing up Trump trades has been bandied about over the last 72 hours, but until today I haven’t seen anyone just come out and say “the failure of the health care bill was the best thing that could have happened” to the reflation narrative.
Onward to tax reform, finally
In our view, the failure to push through healthcare reform by the GOP last week was possibly the best thing to happen to Trump trades since the inauguration. We believe the probability of tax reform getting done this year has, if anything, gone up and more options have become politically viable after the last two weeks.
Trump trades are crumbling. The Fed hike on March 15 only managed to slow their retreat. The dollar, real yields and financials – the three horsemen of the Trump trades – have given up most of their gains or relative gains in the post-election rally (Chart 1 and 2). Positioning paints an even grimmer picture – the long USD/short EUR positions have been cut back so aggressively that they are closing on their 3-year low (Chart 3).
The marked turnaround in investor sentiment in our view reflects the growing concern that tax reform, the raison d’être of the Trump trades, is at risk. Our investor sentiment survey conducted on March 17 shows that only 6% of investors believe tax reform will be done before the August recess (versus 23% a month ago). About a third of the respondents think that tax reform will not get done this year (Chart 4). More recent informal surveys suggest pessimism has grown further since then.
Some might view the failure of the GOP to push through healthcare reform last week as the final nail in the coffin for the Trump trades, but we don’t share this negative assessment. In our view, if anything, the opposite may be true:
- The failure to repeal Obamacare has vindicated the long held position of President Trump that a comprehensive reform of Obamacare is not possible without a super majority in the Senate. This should support Trump’s push to tax reform, his stated policy priority.
- Trump might have gained some leeway in terms of his ability to drive the tax reform agenda and forge a consensus across opposing camps, including the weakened Republican House leadership, the Freedom Caucus and even the Democrats.
- Politically, the GOP leadership knows they cannot afford another major failure before the mid-term elections of 2018.
We don’t want to underestimate the challenge of crafting a comprehensive tax reform that is both good for both the economy and politics. However, we see the fact that tax reform is back in focus as the best thing that has happened for the Trump trades since the inauguration. We can’t help but to see the recent dip in the USD and US rates as providing better entry levels for re-initiating the Trump trades.