End of Trump rally boosts safe havens but is it too early to bring out the bears?

The latest controversy in the White House appears to have been the nail in the coffin for the Trump rally that gripped the markets when Donald Trump unexpectedly won the US presidential election on November 8. The Trump campaign’s promises of big tax cuts, massive infrastructure spending and deregulation boosted equities not just in the US but globally too, and led investors to anticipate a faster pace of rate increases by the Fed due to the potential lift to economic growth.

Revelations this week that President Trump asked the ex-FBI Director James Comey to drop the investigation into former national security advisor Michael Flynn’s possible ties with Russia were the most serious threat yet to Trump’s presidency. It follows a series of allegations that have been made against Trump and his team since taking office. Things escalated last week when Trump abruptly fired the FBI Director, James Comey, leading many to link the decision to the FBI’s ongoing investigation into possible collusion of Trump’s election campaign team with Russian officials. Those suspicions intensified today after Reuters published a story claiming there were at least 18 undisclosed contacts between the Trump campaign and Russian officials during last year’s presidential race.

US equities, which have been the main beneficiary of the Trump rally, had their biggest one-day drop yesterday since last June’s Brexit referendum. The Dow Jones Industrial Average closed 1.8% lower on Wednesday, while the S&P 500 index fell by 1.6%. The US dollar was also hit hard, with the dollar index slumping to a 6-month low to levels not seen since the day after the US election.

However, against the yen, the dollar has managed to retain almost 50% of its post-election gains even after yesterday’s 2% drop that took the greenback to a 3-week low below 111 yen. US stocks also remain in bullish territory despite the biggest upset to hit the equities market this year. While a strong corporate earnings season is underpinning share prices even as hopes of a fiscal stimulus this year fade, the dollar’s outlook is mostly being driven by the Fed.

Expectations that the Fed will raise rates more than twice in 2017 have diminished sharply over the past week, with Fed fund futures implying a 32% probability (as of May 18) that there will be a third a rate this year. However, the markets still think that the Fed is on course to raise rates in June by a further 25 bps, although the odds have declined from over 80% to about 65%.

Recent data out of the US has been on the soft side, and without the prospect of an impending growth boost to the American economy from fiscal measures, it would only require one bad jobs report to jeopardise a summer rate hike. Such a scenario could be enough to push dollar/yen back towards the 100 level. But for now, there is little to suggest that the US economy is about to take a turn for the worst (especially with the labour market so tight), even if growth has lost some momentum.

In the meantime, the current bout of risk aversion has brought safe havens back in favour with traders. Gold surged to a near 3-week high of $1265 an ounce earlier today, while the Swiss franc hit its strongest since November against the greenback at 0.9762 per dollar. Sovereign bonds also rallied, pushing down yields. Ten-year US treasury notes had their largest one-day yield drop since June 2016 on Wednesday. The 10-year yield declined further today, falling to a 4-week low of 2.181%. However, this is still above the April low of 2.165% when geopolitical concerns over the French election and North Korea had spooked the markets.

With the wider economic outlook for global growth looking up and political uncertainty in Europe fast disappearing, the latest setback for risk assets appears to be another temporary blip. However, even if there are enough positive fundamentals to put a floor to the current sell-off, the dollar will likely struggle to find fresh impetus for a renewed upside attempt without any progress to Trump’s economic agenda.

As investors digest the possibility of impeachment proceedings being brought against President Trump should evidence of obstruction of justice or collusion with Russia be found, many analysts are unconvinced that this would spell the end of the Republican growth agenda. In the unlikely event that Trump is impeached, the Vice President, Mike Pence, would become acting president, meaning the Republican Party would still be pursuing much of Trump’s economic policies.