All Enemies, Foreign, Domestic, Real And Imagined: Full Week Ahead Preview

Through it all (i.e., despite trade uncertainty, Italy’s political drama and ongoing concerns about the sustainability of the domestic political situation as Trump remains at odds with the nation’s top law enforcement agencies and intelligence apparatus), U.S. equities managed to turn in their best May performance since the bull market began.

To be sure, that’s a largely meaningless statistic, but it’s worth mentioning I suppose and if nothing else, it makes for a fun chart and an easy lead-in to my traditional Sunday evening week ahead preview:

Over the weekend, Trump seemed to be more agitated than usual with regard to the special counsel probe and while that drama has recently taken a backseat to more pressing concerns for markets, it’s important to remember that the headline risk around the investigation is still there – it’s just a matter of when the next shoe drops. For those who missed it, here’s a smattering of egregious “covfefe”:

There was No Collusion with Russia (except by the Democrats). When will this very expensive Witch Hunt Hoax ever end? So bad for our Country. Is the Special Counsel/Justice Department leaking my lawyers letters to the Fake News Media? Should be looking at Dems corruption instead?

— Donald J. Trump (@realDonaldTrump) June 2, 2018

Jesse Watters “The only thing Trump obstructed was Hillary getting to the White House.” So true!

— Donald J. Trump (@realDonaldTrump) June 3, 2018

As only one of two people left who could become President, why wouldn’t the FBI or Department of “Justice” have told me that they were secretly investigating Paul Manafort (on charges that were 10 years old and had been previously dropped) during my campaign? Should have told me!

— Donald J. Trump (@realDonaldTrump) June 3, 2018

….Paul Manafort came into the campaign very late and was with us for a short period of time (he represented Ronald Reagan, Bob Dole & many others over the years), but we should have been told that Comey and the boys were doing a number on him, and he wouldn’t have been hired!

— Donald J. Trump (@realDonaldTrump) June 3, 2018

Mark Penn “Why are there people from the Clinton Foundation on the Mueller Staff? Why is there an Independent Counsel? To go after people and their families for unrelated offenses…Constitution was set up to prevent this…Stormtrooper tactics almost.” A disgrace!

— Donald J. Trump (@realDonaldTrump) June 3, 2018

Simply put: his paranoia has reached new heights. No one ever accused Trump of having a particularly good poker face and all of the above seems to suggest he’s becoming increasingly concerned although it’s possible that what set him off was the revelation that his legal team has been dodging a subpoena for months (more on that here).

Barring some kind of escalation on that front, markets will remain focused on Italy and whether the tenuous coalition government that finally came together late last week will be inclined to adopt a conciliatory stance towards Europe or whether they’ll immediately start pushing the envelope when it comes to antagonizing Brussels. As noted on Saturday, it’s unlikely that the myriad contradictions inherent in the current juxtaposition can be resolved in an expedient fashion.

The prospect of new elections in Spain only raises the political stakes across the pond. Here’s Barclays, from their week ahead outlook:

While confirmation of an Italian 5SM-League coalition government avoids the need for snap elections, a government led by these parties remains concerning, consistent with still-wide BTP-Bund spreads (Figure 1). We worry on two fronts: 1) fiscal slippage from an economic programme that includes higher spending, lower taxes and a reversal of pension reform in the context of a 1.6% of GDP fiscal deficit and government debt to GDP of more than 130%; and 2) the potential for increased tension with the EU in light of this fiscal slippage. So far, the relatively contained market reaction suggests that markets are primarily focusing on the first channel, but a broadening of this concern to include the second holds clear downside risks to the EUR. Likely snap elections in Spain will add to European political uncertainty but polls (CIS) suggest that the new government is unlikely to represent a material change from the current administration.

While Italian and Spanish assets did manage to rally into week’s end, you’re reminded that amid the turmoil, Italy CDS spreads were at one point wider than Turkey’s, in what amounted to a rather poignant illustration of just how vexed people were with the “Italian job” (so to speak):

All of that is likely to be euro negative in the near term and as Bill Gross discovered last week, rate differentials are predisposed to moving further in favor of the greenback in an environment where late cycle fiscal stimulus will likely mean the U.S. economic expansion (already the second-longest in recorded history) has a bit more room to run while Q1 suggested the eurozone economy may have peaked (last week’s upbeat inflation prints notwithstanding). Throw in the fact that the same late-cycle fiscal stimulus push in the U.S. and the threat of tariffs raise the chances that inflation will materialize and you’re left wondering what stops the policy divergence theme (i.e., Fed policy becoming ever more tight relative to the ECB’s policy stance) from reasserting itself with a vengeance. Here’s Barclays one more time:

The ECB is unlikely to respond to last week’s higher April inflation, given weak economic growth prospects and subdued underlying inflation that is likely to remain below 1.5% y/y through to the end of next year. As we noted earlier this year, carry has become increasingly important as US interest rates have become the highest in developed markets. To hold a long EURUSD position currently costs you more than 3% annually and this is likely to become more punitive if our forecasts of 175bp of Fed tightening by the end of 2019, versus 40bp of ECB hikes over the same period, are correct. Positioning is also unlikely to impede further EUR depreciation. EURUSD vol-adjusted skew is not extremely negative (Figure 2) and EURUSD positioning in FX futures markets remains relatively long (Figure 3).

Speaking of Turkey (that’s kind of a non sequitur, but I mentioned Turkey briefly above, so it’s fine), CBT meets on the heels of a series of steps taken to arrest the run on the lira. Those steps began with a second LLW hike in the space of a month and culminated in an announcement that the central bank is simplifying monetary policy going forward. That’s the context for Monday’s closely-watching inflation data. As you’re aware, inflation has spun out of control in Turkey, a development that, in Erdogan’s mind, is due to interest rates that are too high, and that right there underscores why folks are so concerned about what happens to central bank independence after this month’s election (i.e., will his unorthodox views on FX, inflation and rates become enshrined in monetary policy as he suggested in a laughably deadpan Bloomberg interview from last month?). The lira’s good week (it pared gains on Friday, but overall, last week brought some welcome respite) was due not only to the CBT official announcement on policy simplification, but also to indications that the country will be willing to hike rates in the week ahead (on Thursday) if Monday’s inflation data surprises to the upside. Here’s Bloomberg:

Turkey is prepared to raise interest rates again if inflation accelerates, according to two money managers who met with Turkey’s central bank Governor Murat Cetinkaya and Deputy Prime Minister Mehmet Simsek in London Tuesday. The lira extended its advance.

Further tightening will depend on May inflation data to be released on June 4 and the nation won’t resort to introducing capital controls, the people cited the officials as saying. They asked not to be identified because the meetings were private.

Here’s how things have evolved since the emergency rate hike (Friday’s weakness was attributed to downgrade concerns/rumors):

Meanwhile, trade tensions are back on the frontburner after Trump’s ill-advised decision to slap tariffs on the E.U., Mexico and Canada. The next question is what happens if he goes through with his threat to effectively go back on the truce with Beijing negotiated by Mnuchin two weeks ago. China has an answer to that:

CHINA SAYS U.S. TRADE DEAL OFF IF TARIFFS ARE IMPOSED: XINHUA

— Heisenberg Report (@heisenbergrpt) June 3, 2018

“US trade policy is a conundrum. Less than two weeks after the Trump Administration declared the trade war “on hold”, the White House has announced that it will impose tariffs on steel and aluminum imports from Canada, Mexico, and the EU from June 1, and that it will finalize a list of tariffs on imports from China by June 15,” Goldman wrote in a note dated Saturday, adding that “the trade war appears to have gone from ‘on hold’ to simply ‘on’, leaving even longtime observers of trade policy confused about the direction from here.”

Right. Trump would have you believe this is all part of some grand game of three dimensional chess, but believe me, it’s not. There simply is no plan. Here’s what he said/shrieked over the weekend:

When you’re almost 800 Billion Dollars a year down on Trade, you can’t lose a Trade War! The U.S. has been ripped off by other countries for years on Trade, time to get smart!

— Donald J. Trump (@realDonaldTrump) June 2, 2018

Needless to say, the renewed trade tension has exacerbated concerns about the future of NAFTA and Canada’s retaliation to the tariffs only underscores those concerns. “The BoC delivered a hawkish hold at its May meeting [and] the bank remains data dependent and indicated that it will take a ‘gradual approach’ to policy adjustments,” Barclays wrote, in the same note mentioned above, before adding that “the main risk that remains in the BoC’s list of concerns now is the potential disruptive US trade policy actions [as] the US implementation of tariffs to aluminum and steel imports, and Canada’s dollar-by-dollar retaliation, represent an additional deterioration in the already-strained trade relation.”

Also this week, we’ll get the RBA and a couple of notable econ prints from down under. Here’s BofAML:

Our economists anticipate Australian GDP will come in at 1.0% q/q for Q1. This would raise the annual rate to 2.9% y/y from 2.4%, bringing growth back above trend and offsetting concerns over tighter credit conditions. On Tuesday we expect the RBA to remain on hold with the cash rate unchanged at 1.5%.

Finally, there will be no shortage of headlines regarding the apparently back-on-schedule Trump-Kim summit. The surreal meeting at the White House last week that found a North Korean spy chief presenting Trump with a letter the size of one of those fake lottery checks only served to make the situation even more cartoonish than it already was.