We are gob-smacked that the uncertainty accompanying a Trump presidency has so quickly been converted to the appearance of normalcy in the equity and FX markets. A candi-date pretending to be for the little guy when he has stiffed the little guy on wages and contrac-tor pay, and who clearly prefers the company of bimbos and glitterati over theirs, is hardly likely to seek economic outcomes favoring the little guy. (And when you think of how Trump will redecorate the White House in his garish bad taste, you want to cry.)
Trumps' version of populism entails policies that will harm the little guy, especially trade and deregulation. Disrupting the global supply chain with tariffs will trigger lost jobs and higher prices for everything from socks to i-phones. Students in Econ 101 learn about Smoot-Hawley in 1930, which cut trade in half and prolonged the Great Depression. After an initial gain, unemployment rose dramatically. Countries like Canada started retaliating even before the bill was passed. Those favoring Trump's ideas today are forgetting the debates surrounded NAFTA. The economics of free trade have not changed.
As for deregulation, Trump would roll back consumer protection from predatory banks, pollution controls, and any effort to rein in medical costs. The little guy is about to get hosed financially and to be sick without insurance or affordable meds. When uneducated people elect a leader, they get an uneducated policy response.
If Trump's ideas are so awful, why are markets recovering? The most likely answer is that traders expect fresh government spending on infrastructure to come first. A big rise in government spending is indeed stimulus. It's also something Congress has denied for eight years, for the simple reason that government borrowing has already taken the cumulative debt to over $17 trillion and 105% of GDP. All the same, the rise in US yields is probably down to expectations of fresh government spending—as much as $1 trillion. And the promised tax cuts, if they come for the lower and middle class, are inflationary. Everybody and his brother, from the IMF to Draghi and former Fed chief Bernanke, has pointed out that monetary policy has reached the end of its rope. Fiscal spending is needed to pick up the baton.
This is why the Fed is likely to stay on course for a hike in December, contrary to what Mr. Authers said yesterday in the FT. He would have been right about the Fed standing pat if the financial markets had continued to freak out, but the charts are telling a different story today. Today the picture has changed to acceptance of the Trump vision, including higher government spending and inflationary tax cuts and tariffs. It's too soon for Fed economists to be changing their outlook, but their outlook already had justification for the Dec hike. In fact, sometime next year, if Trump gets the changes, the outlook for inflation is far higher and rate increases could return to the old dot-plot—four or more per year instead of a measly one.
What about Trump firing Yellen? Technically, he can't do it. The Fed is independent. No president has asked for a Fed chairman to resign, although the Reagan administration may have helped engineer Volcker's resignation in June 1987 (to be replaced by Greenspan). The ostensible reason was a majority of the Fed board disagreeing with chief Volcker on policy. As for the legal status of the Fed, you can argue about it until the cows come home (and we have). It's a public, federal institution that reports to Congress but it's also a private entity, with each regional Fed organized along private corporate lines. Yellen is highly unlikely to resign, even if asked, if only to maintain the Fed's independence. Congress is unlikely to agree to a revision of the law establishing the Fed—not to be sarcastic, but it would literally be far too much work. Yesterday on CNBC, with its typical disregard for context, commentators proposed replacement John Taylor, he of the Taylor Rule and now at the Hoover Institute. Taylor was dignified and didn't come right out and say the analysts were talking through their hats, but no serious and high-stature economist would accept the job as Fed chairman under these circumstances. It would make him a puppet of an irresponsible showman and taint his reputation forever. Only a dumb glory-hound would take the job.
All the same, uncertainty looms over everything. Markets are happy to price in fiscal stimulus as an antidote to less monetary stimulus. So far. But the immediate hope is not the long-term outcome. Some analyst think that if the market tightens conditions in expectation of Trump policies, the Fed can stand back and let the market do its work. Here's the response to that idea from JP MorganChase economist Feroli: "While fiscal and economic policy uncertainty has increased, it would be a challenge for Fed rhetoric to maintain an aura of being above the political fray if that were the only rationale for not moving next month." Now that's a good economist.
Markets initially lowered the odds of a Dec Fed to 55% (Bloomberg says below 50%). Bloomberg reports Goldman cut the chances of a December rate rise to 60% from 75%. But as of this morning, the odds have risen back to 71% (CME) and as much as 82% (Bloomberg).
Bottom line, Trump can fill two existing vacancies in January and replace Yellen in Feb 2018 when her term expires. Trump lacks patience but it looks like his hands are tied unless he chooses to make a stink. Besides, the Fed is going to be doing what he wants, anyway—hiking rates and deflating what he sees as a stock market bubble. The implication is that the yield curve shifts upwards. Rising inflation expectations on tax cuts, tariffs and higher government spending will make the Fed more hawkish. And this is why banks stocks did well yesterday. It's also why the rising dollar outlook is suddenly back on track.
Unfortunately, an awful lot can go wrong. Just as we know far too little about contamination in financial markets—how a drop in the Shanghai causes the Dow to tank—we know too little about uncertainty. We can measure it, sort of, with things like VIX and the various regional Fed measures, but the ultimate test is always price action itself.
One thing we do know—in a crisis, asset classes far distant from one another suddenly get correlated. There is no real reason for a rise in industrial metal prices to affect yields, for example. Producer country currencies, maybe, and stocks market indices heavy with metals producers (including oil), but yields? And yet that's what we are seeing today. Industrial commodity prices are higher (copper, zinc, iron) in part on the idea that Trump will splash out on infrastructure spending, causing inflation elsewhere, too, hence the yield rise. It might be a good way to trade short-term but it stretched the assumption chain and is not reliable as an analytical mode.
Another case of a stretch assumption chain: In Germany, the FT reports "Germany's 30-year government bonds are suffering their biggest weekly sell-off in a year as yields creep towards 1 per cent, according to data compiled by Reuters. The 30-year Bund yield has risen 0.21 percentage points so far this week, reaching as high as 0.94 per cent – their highest level since April. Investors are dumping Germany's long-dated debt - and other fixed income instruments today – on the prospect of higher inflation globally, driven by expectations that the future president Trump will switch on the fiscal taps." We need to remind ourselves that markets are not always "right." They are right in the sense that a single trader can't move the market, unless he's Soros or Buffet. He has to take the price in front of him, but that doesn't mean the judgment behind prices moves is not really quite stupid.
We are almost certainly going to get times when uncertainty rises to crisis levels under a Trump presidency. It's not hard to imagine statements or actions consistent with campaign statements and actions that trigger massive negative market moves. The tiger doesn't change his stripes. Here's a cute tidbit from Quartz: The Back to the Future 2 villain was based on Donald Trump. Make no mistake—Trump may not be a villain but he's also not qualified to be president and is sure to make some truly horrible mistakes for which investors and traders will pay dearly.
The long-run outlook is still murky. The markets may have overreacted to the downside on the Trump win but the judgment is sound. That they are overreacting to the upside now is whistling past the graveyard— untethered wishful thinking. We are certainly going to get some real trouble from China, for example. And Mexico.
We like cash.
This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.