As it turns out, when you and all your friends are being investigated for colluding with a hostile foreign power to undermine America’s democracy, it’s hard to get anything done.
And that makes sense because you know, when everyone thinks you might be a Russian spy, it makes it hard for them to trust you or otherwise help you advance your agenda.
Sure you can still get some things done – like say pushing the Korean peninsula to the edge of nuclear war and destroying the environment – but when it comes to things like tax reform and fiscal stimulus (i.e. things you can’t do unilaterally) the whole effort tends to get bogged down when everyone is concerned about the very real possibility of you committing treason.
That, in turn, is a real pain in the ass for markets, which went ahead and priced in your agenda and (apparently incorrectly) assumed that you wouldn’t end up getting yourself impeached.
Well, since it’s become apparent that all is not well in the House of Trump, the market has unwound the reflation bets – and then some. Specs have covered shorts in Treasurys (they’re now the most long the 10Y they’ve been since December 2007), the curve is flatter than it was before the election, the dollar is in the dumpster, and so on and so forth, even as Trump insists that if only you’d wake up and smell the “covfefe,” #MAGA is right on track.
So that brings us to SocGen, who on Friday threw in the towel on their year-end 10Y yield forecast citing… well… citing the fact that the US has a shrieking pumpkin with a bad Twitter addiction and a weird affinity for the Kremlin for a President.
We lower our 10y Treasury forecasts to 2.70% for year-end (from 2.90% before). Recent political developments are likely to hinder the Trump administration’s ability to advance its pro-growth policies.
Philadelphia’s Fed’s Harker recently said he’d like the unwinding of the Fed balance sheet be about “as boring as watching paint dry”. So far so good! With 10yT in a range of less than 50bp over the past six months, it hardly gets more boring than this. Meanwhile, global nonfinancial debt keeps rising to new record highs and risk assets are partying for longer. The unwinding of leverage globally may be slow, but it is necessary, and central banks need to unwind accommodation on their side too.
Asset price inflation instead of consumer price inflation: we’ve seen that movie before. The Fed as an institution has never come close to accepting the idea that the very gradual policy tightening of 2004-2006 (though very steep by today’s standards!) set the scene for the Great Financial Crisis. Instead, it conveniently linked depressed bond yields to the saving glut and the housing bubble to deregulation. The road to hell is paved with good intentions: the persistent inflation undershooting and the downside risks (especially global excess leverage) associated with policy normalisation are seen by the Fed as meriting caution. Yet procrastination encourages further leverage and more bubbles. We see these risks as becoming more symmetric and expect central banks to take further steps towards unwinding easy money. Inflation signals will dictate the pace, but the direction is clear.
Hence, our bias remains bearish, with – we hate to say it – less conviction over the next six months. Indeed, persistent political uncertainty and indecisiveness are contributing to making both economic agents and central banks more cautious – hence postponing the Big Hangover, the theme of our last Outlook.
The frustration over the past six months has mainly come from the US, and the political fog there may not dissipate quickly. A lengthy investigation into Trump’s Russian links could still derail the policy agenda, with deregulation and other controversial fiscal items potential casualties. There is also the debt ceiling, which will be hit by late summer. At this stage, it is not clear whether lawmakers will vote to raise it before the August recess; if not, uncertainty will hang over markets. Some Republicans will want to make the increase conditional on spending cuts, potentially setting investors up for yet more political intrigue.
Graph 3 suggests that Trump’s approval rating has influenced the direction of Treasury yields, if only through sentiment about his capacity to deliver on fiscal and regulatory changes. The ‘Trump trades’ have been unwound somewhat: bond yields and the US dollar have pulled back, while in equities the construction and engineering sector has performed poorly on disenchantment about infrastructure spending (Graph 4). Long speculative positioning data in Treasury futures is one measure of the extent of the unwinding so far. In contrast, equities have been very resilient to the forces behind the unwinding of the Trump trade. That is because doubts about Trump’s effectiveness and soft inflation readings have reinforced the goldilocks scenario, leading investors to expect a very slow removal of global monetary policy accommodation.
So basically, equities are the last man standing and the hope is that the Trump drama is just acute enough to stymie central banks’ normalization plans but not traumatic enough to send things into a tailspin.
Sounds like a delicate balancing act – and no one has every described Trump as “delicate.”