A more pragmatic outlook on the Trump reflation trade could be dollar-favorable

Outlook:

The dollar has a chance to recover from an oversold condition if the market comes to feel that the sell-off was overdone, just as the original build-up had been overdone. A more pragmatic outlook on the Trump reflation trade could be dollar-favorable. This doesn't take away the weight from an insufficiently hawkish Fed, but it would help.

It's not clear that this is going to happen, though. Assuming the health care bill does fail today and the White House moves on, hopes are high for infrastructure projects. After all, Trump is the guy who got the New York City skating rink built after the city failed for a decade to get it done. This was mostly a matter of replacing city labor union workers with private sector non-union labor, a simple fix that won't suffice when it comes to coordinating city, county, state and federal programs. Again, governing is very different from running a private business. It's not that skills don't translate—it's that the parties have competing interests and can't be shoved out the door. Maybe Trump is good at one-on-one negotiating, chiefly by throwing tantrums, but how about one on fifty? Bottom line, renewed optimism about new fiscal stimulus faces very high hurdles.

Also helpful to the dollar might be developments elsewhere that are currency-negative. Several analysts are watching next week's inflation data from the eurozone, forecast a bit lower and signaling a halt, if temporary, to taper talk. RBC says "We expect that run [of 6 months of rising inflation rates] to have come to an end this month. With the oil price effect abating and underlying inflation still weak, we see headline inflation continuing to moderate from here and falling to 1.5 percent year-on-year by year-end." Well, maybe. But growth is robust, according to today's eurozone PMIs, including both Germany and France's own indices. See the chart. Growth alone doesn't deliver inflation, of course, but it's a prereq-uisite. And oil is not the only contributor. In Europe, traditionally the inflation-driver is the so-called "secondary" effect—wages.

Then there's Brexit, which becomes real next Wednesday when PM May triggers Article 50 with a letter to EC Council chief Tusk. He in turn sends "draft negotiating guidelines to the member states within 48 hours. This means it has already been drafted and we await leaks about what it actually says. So far we know the UK is holding out for control over immigration while the EU insists on some say in the matter.

Europe may hold May to her commitment to give up quite a lot on trade, maybe everything, to keep the sovereign right to control immigration. It's not pretentious to emphasize the sovereignty aspect of Brexit.

And EC President Juncker, who has said some nasty things about Brexit, now says the UK has to honor commitments made previously to various projects, including infrastructure, and that will cost about £50 billion. This is not to punish Britain and not sanctions, just paying for things committed. This weekend is a celebration of the 60th anniversary of the Treaty of Rome that started the whole EMU project. The Brexit letter coming in the following week is a bit of irony.

The political stuff is interesting, but let's assume that real economic data must underlie FX moves, and the one indicator that incorporates all the data is the 10-year yield. Not all data gets equal treatment. For example, today the Atlanta Fed will release the latest Q1 GDP estimate. It may not move the 10-year much, if at all. The eurozone just released PMI data showing a 70-month improvement and we can't really say the minor gain in the Bund reflects that fully. Both areas have inflation near 2%, the central bank target, while the Fed will be hiking but the ECB sitting on its hands until year-end, proba-bly. So while the machinery is thumping along in the basement, the operator in the tower is drinking coffee and reading the paper.

This is one reason sentiment is changing so slowly and everyone is willing to be distracted by the shiny new things in politics. Silence from the central banks allows those shiny new political things to domi-nate. On Wednesday, the US 10-year yield fell to 2.398%, the lowest close since the end of February. We have to blame politics. Politics promised higher growth and thus inflation, and now it looks like the slow-growth model will persist, unless Trump can pull a rabbit out of the hat. The US will be lucky to get 2.5% growth this year. Promises and hopes of 4% are circling the drain, while meanwhile, Europe is at a lesser level but a faster pace. It's the pace that counts.

We have two factors—not only the absolute numerical premium of the US note over the Bund and the pace at which the differential changes, but also the credibility of the sovereign. The US bond market does not believe the Fed will deliver another two hikes this year. To make matters worse, the credibility of the US government is not so hot, either, especially the credibility of the president. He is viewed as not qualified, not competent, not tempermentally and maybe not mentally fit, and not honest.

In contrast, the two top European leaders, Merkel and Draghi, are admirable.

So, if the US has to offer 2.5% or more in yield over the Bund to hang on to any dollar advantage, Trump raises the necessary premium by some amount, say 25 to 50 bp. We don't see the yield ad-vantage rising that much any time soon. It would take a gigantic Trump win to get the dollar rolling again. And that doesn't look likely. It's interesting that the dollar is moving more on the shenanigans of Congress and the president than it moved when Congress was refusing to fund the national debt. It's probably an indicator of extreme fear.

Politics: If the heathcare bill is defeated in the House vote today, Trump will have failed as the best deal-maker ever. He didn't know "how complicated healthcare can be." Trump thought he could avoid doing the homework and skate on the force of personality. He also allowed himself to be dra-gooned into supporting the Ryan version, supposedly seven years in the making, without checking its feasibility, a bit like hiring an architect without reviewing his other buildings. Worse, he didn't do his homework on the politics. He was counting on one wing of the Plubs to do the actual work but neither he nor the Ryan wing can control the other wings, let alone work with the Dems.

Funny story: one legislator voting against the new bill saw his party money machine literally close up its office in his district. He's sticking to his guns anyway.

The WSJ writes "If Republicans can't pass a health-care overhaul despite control of both the legislative and executive branches, some veterans of past administrations wonder if the party can usher in other pieces of the Trump agenda that are backed up on the runway, including new spending for roads, bridg-es and ports. ‘Failing to move it out of the House risks a cascade effect that suddenly pushes back other initiatives like tax reform and the infrastructure program,' said Craig Fuller, who worked for eight years in Republican President Ronald Reagan's White House. ‘And that begins to raise doubts about how much they can get done in the first year, which is a very important year in his presidency.'"

On another front, Trump's anti-global campaign promises may get watered down so much that they no longer pose a threat to the dollar. In what looks like a scoop for the WSJ, AFL-CIO union chief Trumka has been visiting the White House regularly and reports there is a "normalcy" trade camp the opposes the worst of the toxic ideas. Trumka supports killing all the trade deals, as Trump promised, but so far is dragging his heels on things like picking a fight with China and renegotiating NAFTA. He says there is a "Wall Street Wing" in the White House made up of sane, experienced guys from the likes of Gold-man Sachs who are working in opposition to advisor Bannon and trade advisor Navarro, the guys who want to burn the barn down. So far the trade hawks are losing.

One that is not losing is Commerce Secretary Ross, who intends to take on currency manipulation the government naming some countries has having "unfair subsidies," when companies can then take to the WTO. Even some Dems don't mind this approach. We say the WTO will throw it out, whereupon Trump will withdraw from the WTO, either formally or not, and impose tariffs instead. Trumka is a savvy guy. If he says the Ross plan is where the action will be, we believe him.

So now we have to judge whether a saner trade policy outweighs the postponement of fiscal stimulus until later in the year or even next year. We'd guess no.                                      

Currency	Spot	Current Position	Signal Date	Signal Strength	Signal Rate	Gain/Loss
USD/JPY	111.11	SHORT USD	03/21/17	WEAK	115.93	1.24%
GBP/USD	1.2495	LONG GBP	03/22/17	STRONG	1.2451	0.24%
EUR/USD	1.0799	LONG EURO	03/16/17	WEAK	1.0587	0.82%
EUR/JPY	120.00	SHORT EURO	03/13/17	STRONG	121.56	-1.80%
EUR/GBP	0.8642	LONG EURO	03/02/17	STRONG	0.8605	0.78%
USD/CHF	0.9914	SHORT USD	03/16/17	WEAK	1.0113	0.81%
USD/CAD	1.3352	SHORT USD	02/22/17	WEAK	1.3253	1.35%
NZD/USD	0.7014	LONG NZD	02/10/17	STRONG	0.7014	2.38%
AUD/USD	0.7625	LONG AUD	03/16/17	STRONG	0.7343	-0.79%
AUD/JPY	84.73	LONG AUD	03/22/17	STRONG	78.48	0.55%
USD/MXN	18.9095	SHORT USD	01/31/17	WEAK	20.8108	9.14%