Shenanigans in the White House and a political crisis in Brazil spark markets into life
After months of declining volatility, a turn in risk sentiment saw a flight to quality trade across global markets in the past week. The ‘fun’ started over the weekend, when Donald Trump predictably made a mess of the decision to fire the head of the FBI, James Comey, and then allegedly revealed classified intelligence to the Russian Foreign Minister and Ambassador in a meeting at the Oval office. Coming on the back of weaker US economic numbers last week (Retail Sales and CPI Inflation), the furore escalated and equity prices slipped from their highs after seeming to be impervious to the ongoing shenanigans surrounding the White House. The VIX measure of S&P 500 volatility jumped more than 50% and US Treasuries rallied as investors heavily discounted prospects for future Federal Reserve (Fed) tightening.
Notwithstanding this, our focus is primarily on whether this latest storm and the recent data releases have changed our fundamental view on the US economy. Here the answer is that it has not. This week’s labour market data (claims at historic lows) and a strong Philly Fed survey reinforce our confidence that the underlying structural economy is robust and that as long as the S&P does not experience a much more severe down move, we see nothing to suggest that the Fed will deviate from their normalisation of rates. At the March meeting, the FOMC dots suggested five more hikes until the end of 2018 and we believe that this path will remain unchanged in June, with the Committee hiking at this meeting and signalling a gradual path. This will take the Fed Funds rate back towards a neutral rate above 2% in the year ahead, with the economy close to full employment and with inflation close to its target. In this context, we believe that the pricing at the front end of the US curve is more asymmetric than ever, with market prices discounting no more than two hikes between now and the end of next year.
As always, it is important to ignore the hype and hysteria that is a feature of the news cycle and focus on the nuggets of information that are really important.
Elsewhere, the tone in markets was also impacted by news flow in Brazil, where a sting operation has resulted in President Temer being taped, seemingly condoning payments to a convicted politician in order to keep him quiet in the course of the ongoing corruption investigation. For Brazil, this would normally not be news, but it comes at a crucial time for the passage of the critical social security reform. The pension fund reform bill was due to be put to a vote in Congress in the coming weeks and much of the positive sentiment generated in Brazil in recent months has been built on its successful passage. The event drove volatility another leg higher with Brazilian markets hitting downside circuit breakers and broader emerging market (EM) related assets initially hit hard. However, it has been encouraging that the price action has been two-way and there has been little evidence of panic selling.
As we look ahead, we continue to voice the view that Capitol Hill remains more important with respect to the US legislative agenda than the White House. Trump appears to be a bit of a circus – but even were he to exit the stage, the prospect of Pence would probably be viewed even more bullishly by business and financial markets. In the short term, we see the announcement of a Special Counsel to take control of the investigation into potential collusion with Russia is a constructive step. Robert Mueller is a hugely respected figure by both Democrats and Republicans and will have free reign to provide a decisive ruling on whether there is a case to answer on collaboration between the executive branch and the Russian state. This will not be a quick process, but it’s our expectation that it will calm the overhyped hysteria.
Moreover, if distractions can be contained, Congress is now focusing on proposals for the Budget and the business of crafting tax reform. We stick to the view that they are very motivated to get traction on this before the political cycle kicks in for the mid-term elections in 2018 and that by September we should have managed to reach an agreement with regard to tax cuts at a minimum. As always, it is important to ignore the hype and hysteria that is a feature of the news cycle and focus on the nuggets of information that are really important. In that context, we see little reason to change our current views. In this sense, the recent spike in volatility is welcome as we believe it provides us with great opportunity potential to take advantage of mispriced assets.
A trend of falling volatility and range bound markets continue to prevail, but for how long?
By Mark Dowding, published 12 May 2017 (2 minute read)
As the French elections come to a crescendo, global markets appear robust for now
By Mark Dowding, published 5 May 2017 (2 minute read)
The Trump administration unveils an ambitious tax plan and risk-on impulse fades after Macron’s first round victory
By Russel Matthews, published 28 April 2017 (2 minute read)
This document is issued in the United Kingdom (UK) by BlueBay Asset Management LLP (BlueBay), which is authorised and regulated by the UK Financial Conduct Authority (FCA), registered with the US Securities and Exchange Commission, the US Commodity Futures Trading Commission (CFTC) and is a member of the National Futures Association (NFA). Past performance is not indicative of future results. All data has been sourced by BlueBay. To the best of BlueBay’s knowledge and belief this document is true and accurate at the date hereof. BlueBay makes no express or implied warranties or representations with respect to the information contained in this document and hereby expressly disclaim all warranties of accuracy, completeness or fitness for a particular purpose. This document is intended for “professional clients” and “eligible counterparties” (as defined by the FCA) only and should not be relied upon by any other category of customer. Except where agreed explicitly in writing, BlueBay does not provide investment or other advice and nothing in this document constitutes any advice, nor should be interpreted as such. No BlueBay Fund will be offered, except pursuant and subject to the offering memorandum and subscription materials (the "Offering Materials"). If there is an inconsistency between this document and the Offering Materials for the BlueBay Fund, the provisions in the Offering Materials shall prevail. You should read the Offering Materials carefully before investing in any BlueBay fund. This document does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product in any jurisdiction and is for information purposes only. No part of this document may be reproduced in any manner without the prior written permission of BlueBay Asset Management LLP. Copyright 2017 © BlueBay, the investment manager, advisor and global distributor of the BlueBay Funds, is a wholly-owned subsidiary of Royal Bank of Canada and the BlueBay Funds may be considered to be related and/or connected issuers to Royal Bank of Canada and its other affiliates. ® Registered trademark of Royal Bank of Canada. RBC Global Asset Management is a trademark of Royal Bank of Canada. BlueBay Asset Management LLP, registered office 77 Grosvenor Street, London W1K 3JR, partnership registered in England and Wales number OC370085.
Published May 2017