North Korea, Russia and French elections are causing market jitters but fundamentals remain intact
Treasury yields have continued to rally over the past week, as risk-off sentiment has led to market jitters in the run up to Easter. A souring of US-Russian relations following the missile strike in Syria, coupled with the decision to send the US fleet to the Korean peninsula has led to worries that President Trump is shooting from the hip on the international stage, as his domestic policy agenda fails to gain traction. Markets are very much in a mood to ‘sell Trump’ at the moment and it may be that pessimism with respect to the administration is overdone at this point. Budget discussions are likely to continue into June and we continue to believe that the Republican Party won’t want to score a monumental own goal by failing to achieve anything at a unique point when the GOP controls the Congress, Senate and the Executive Branch. In this context, we continue to take the view that some (but not all) of Trump’s agenda will eventually get done and we are hopeful, having analysed how the Administration has approached states like Mexico and China (in contrast to the rhetoric ahead of the election), that a pragmatic foreign policy approach will prevail and that military adventures should be less likely not more likely, under this particular regime.
The proximity of the French elections also added to market worries in recent days, with the first round of voting due at the end of next week. This rise of Melenchon in the polls has introduced some uncertainty into a vote, which had shaped up to deliver a Le Pen versus Macron run-off in the second round. We would note that Melenchon has performed well in opinion polls in the past, only to disappoint when votes are cast – though with support for the other socialist candidate, Hamon, in free-fall, Melenchon’s progress needs to be carefully monitored in the days ahead. In many regards, we feel that the first round of French voting promises to be more unpredictable than the second round as we remain very confident that Le Pen would be well beaten by either Macron, or Fillon were these centrist candidates to prevail. Ultimately we continue to view the risk of Le-Pen winning at no more than 20% and this probability seems fairly built into market prices, but with many investors running long of credit risk in various forms, the temptation to hedge exposures over the vote has seen some weakness in both corporate and sovereign credit spreads in the region over the past week.
We expect markets should look through some of the noise and we fully expect expectations for Fed rate hikes to be resurrected after Easter.
Economic data releases this week have been broadly robust. In the US, small business confidence continues to run close to its recent highs, jobless claims and JOLTS job openings appear to confirm the rude health of the US labour market and early retail spending reports seem to suggest that March was a solid month after a blockbuster January was followed by weaker February data. In the eurozone, the ZEW survey continues to highlight the ongoing boom underway in the German economy and Chinese data also confirmed that the economy retains substantial momentum, even if peak policy easing is now behind us. A robust outlook in China has also seen further strength in Australian data, with strong jobs gains on the month. Australia is a very cyclical economy and with data across Asia also looking strong we see plenty of evidence to believe that the global upturn in growth we have witnessed in recent months remains very much in full swing. Against this backdrop, we remain confident that the Federal Reserve (Fed) is likely to hike in June and again in the third and fourth quarters. Indeed Fed Chair Yellen’s comments this week suggesting that the economy was close to full employment and that policy should be close to neutral, and would get there following a series of rate hikes in the months ahead, were very much in line with our thinking.
Elsewhere, Trump’s comments that the US dollar may be too strong saw the greenback under pressure. It seems that the President would love to talk the US dollar down, but we suspect that his interventions may have little lasting impact. Markets will be determined by fundamentals and arguably there are lots of things which Trump might want that he is in no real position to be able to get. That said, his comments regarding policy preferences could influence his choice regarding the next Fed Chair and one wonders whether some of the forerunners for the job, such as Taylor or Warsh, who are seen as policy hawks favouring tighter monetary policy, will necessarily be in tune with the President’s liking.
Looking forward, there appears plenty going on in macro markets for the time being and with US consumer price index (CPI) due on Good Friday when European market participants are out, we may expect a continuation of short-term volatility. Notwithstanding this, we expect markets should look through some of the noise and we fully expect expectations for Fed rate hikes to be resurrected after Easter...after all we had a reminder this week when something gets overbought, you can expect to get carried out with a bloody nose.
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