Dodd Frankly great for banks, dollar drops

Stocks recoup losses

It was a good finish to what has been a bit of a wishy washy week in stock markets. Donald Trump’s unpopular refugee policies and trepidation before central bank meetings saw stocks plummet at the beginning of the week. There was a change of course after the Federal Reserve and Bank of England gave no indication a rate rise is on the horizon. A mixed US unemployment report that saw more jobs created but wage growth slow was just the kind of goldilocks scenario that markets like best in an era of central bank stimulus.

Financial firms led the charge on the FTSE 100 with Barclays, Prudential and Hargreaves Lansdown all top risers. Reports that Donald Trump is preparing to scale back financial regulations in the US is a boon for multinational ‘megabanks’ which have seen profits drop since the heady days before the 2008 financial crisis.   

Barclays CEO Jes Staley may well be giving himself a pat on the back after announcing a US-UK focus last year. The old Lehman Brothers assets bought up by Barclays Capital will be clear winners from deregulation in the US.

Dodd Frank

Financial firms were clear cut leaders on the open of the Dow Jones on Friday. Shares of Visa, Goldman Sachs and JP Morgan were all atop the US benchmark. There was observable shareholder glee that an era of ever-expanding regulation could be coming to an end under Donald Trump.

Since Dodd Frank was introduced, banks have devoted a lot more capital towards compliance and have had to decrease leverage, both of which are a direct hit to profitability. If Dodd Frank is watered down, that’s a direct boost to the bottom line for banks.

The changes to Dodd Frank are likely to be small to begin with but Trump is shifting the direction of travel from more regulation to less regulation. That’s a good thing for the financial sector, and less red tape is good for corporate America as a whole. Trump turning his attention to deregulation could be just the boost Wall Street needs to send the Dow back above the 20,000 mark.

Too much regulation favours the large institutions who can afford the extra compliance costs.

Unwinding some of Dodd Frank is a good thing because it will enable smaller community banks to compete, offering competition to consumers. Repealing too much of Dodd Frank puts the entire system at risk of a repeat of 2008. The red line is the Volker rule; if the big banks can engage in proprietary trading, then depositors will be put at much greater risk.

Dollar could weaken further after NFP

The US produced 227,000 jobs in January, more than the 175,000 consensus forecast, and a big improvement over the 156,000 in December. Although the headline number beat expectations, the dollar fell and stocks jumped, interpreting the data as reducing the chance of aggressive rate rises. Average earnings growth of only 0.1% m/m, the Fed's preferred inflation gauge steadily below target and new ‘dovish’ members on the FOMC board this year means there is likely no rush to raise rates in March

Conversely, the Eurozone expanded by 1.8% year-over-year in the fourth quarter, in line with expectations. Unemployment remains stubbornly high but there has been a dramatic uplift in inflation which reached 1.8% year-over-year in January. The ECB, for its part downplayed the higher inflation, insisting it will carry out its full QE program.

Clearly the economic outlook for the US is better than the Eurozone – but is it so much better than Federal Reserve and ECB monetary policy should diverge so noticeably? We don’t think so, and that’s why we favour a recovery in the euro over the medium term.