Markets ignore politics—until the politics threaten the status quo

Outlook:

The calendar includes PPI ahead of CPI tomorrow. PPI tends not to feed CPI in the US, so unless there is something peculiar about the number, ho-hum. The WSJ notes Mexico reports industrial production this morning and China reports CPI tonight. Trump is in Iowa to talk about farm policy in the context of the trade wars. More bribery is probably in the cards (farm subsidies).

As we complained yesterday, it's not risk-off that Trump did not put into effect tariffs that were only threatened, i.e., maintaining the status quo. It's actually more risk-on because the last-minute flip-flop demonstrates all too well that this guy is erratic, impulsive, and cannot be trusted. He can threaten to re-impose the tariffs at any moment if he is not satisfied with Mexican actions—all too likely because the migration control task is beyond Mexican capabilities—or for no reason that anyone else can see. And this is on top of the disconnect of trade/tariffs, an economic basic, and national security/immigration, something shared with the spineless Congress.

This is the context in which it doesn't matter one whit whether Senate Republican objections to the Mexico tariffs had anything to do with the cancellation. In addition, what did the Plubs give to Trump in return for a temporary cancellation? If objections had nothing to do with the cancellation, why are the Plubs in control of the Senate?

It doesn't get any worse than this. This is truly the worst-case scenario. Risk aversion should be soaring, not retreating.

Now on to the Fed and its expected rate cuts. Yesterday important fund manager Gundlach tweeted he sees four rate cuts this year. In contrast, today we have important Goldman Sachs economist Hatzius saying "Although it is a close call, we still expect the [Federal Open Market Committee] to keep the funds rate unchanged in the remainder of the year."
Oh, for heaven's sake. Let's note that if the slowdown in the economy is truly severe, rate cuts of any number are not going to prop up the stock market indefinitely. Besides, Goldman is presumably thinking about a normal Fed leadership relying on normal economic analysis, not factoring in that if the Fed declines to cut rates and PDQ, Trump is going to fire Powell, or worse. Conditions are not normal.
We have three things to figure out. First, does the Fed have a sound basis to cut in the form of a deflationary threat? Second, what other effects will Trump's meddling bring about? If he fires Powell, it's one thing; if he fires the whole Board, it's something else—and if he abolishes the Fed by executive order, it's a whole other can of worms. Don't think Trump wouldn't do any of these things. There is no limit to the outrageous things Trump is perfectly capable of doing. He started with dismissing McCain as no war hero. This, from a draft-dodger. Once he got away with that, it's no stretch to abolishing the Fed.
Which brings us to the third thing: what is the effect of rate cuts on the dollar? We made a mistake sticking to the normal scenario that has the currency with the yield advantage winning in the end, once the relative ate of change is absorbed. After all, the only reason to prefer a currency with a negative interest rate/rate of return is if you think its currency is going to appreciate. Up to now, we had no reason to suppose sterling or the euro had the economic chops (or political conditions) to appreciate. The UK faces a hard Brexit and the eurozone has Italy acting like the maverick in a spaghetti western.
But the UK and eurozone are starting to look like paragons of stability and sensibility in comparison to the US. We can understand the yen and the Swiss franc getting the safe-haven bid, negative returns notwithstanding. But the pound and/or the euro? Well, if the US falls farther down the Trump rabbit hole, yes.
We need to widen our perspective to the circumstances under which a currency with a high yield persists in falling despite the advantage. We have plenty of instance throughout history. Nigeria, for example, has very high rates and a lousy currency because confidence in the capability and honesty of the government and economic integrity is terribly low. Rock bottom, in fact. And Nigeria has oil. Back before there was a eurozone, many of us remember high yields in Greece that US fund managers basked in but zero liquidity to get out of the darn paper or the currency once the drachma was in the process of being devalued. You could drive a truck between the drachma bid and offer. We also say the US is hardly Nigeria or Greece, but Trump is rapidly trying to turn the US into a tinpot dictatorship. In fact, the most Trump recent attack on the Fed sounds all too much like Erdogan's attacks on the Turkish central bank only a few months ago. We are required by professional standards to review the inflation/deflation material and other aspects of the near-term outlook for financial conditions and the economy, but let's be honest and admit that much of it is a fruitless exercise when Trump can smash conventional analysis to smithereens on a whim.

About that inflation outlook: the Fed is getting some evidence from the NY Fed that inflation expectations are continuing to fall. The NY Fed's Survey of Consumer Expectations shows respondents expect price pressures rising but at a slower pace. One year out, inflation should be up only 0.25%, less than the public expected in April. This survey group also expects their incomes not to rise. The WSJ reports "Other measures of expected inflation are also softening. For example, the market-based five-year, five-year forward inflation expectation rate has been below 2% since early May, signaling investors and others are losing confidence price pressures will be moving higher. To make matters worse, actual inflation has weakened this year rather than picked up, as officials had expected. In March, the Fed's preferred price pressure gauge, the personal-consumption expenditures price index, was up 1.5% from a year ago, and by 1.6% with food and energy factors taken out."

So far the Fed can live with naming the absence of price pressure as temporary. NY Fed Gov Williams said so only last week. And the Dallas Fed has a measure ("trimmed mean PCE") that was up 2% in March, matching the Fed's target.

That brings the tipping point down to the job market. As noted above, the number of new openings is now higher than the number of unemployed, although we continue to think there is a vast pool of unemployed not being counted as available (in the participation rate metric). But the numbers show 7.449 million jobs available and only 5.824 million job-seekers in April. The WSJ reports "The number of openings increased across education, retail and construction and outnumbered the unemployed by 1.625 million in April, the largest gap on records back to 2000."

The only way to get those secret workers out of the shadow economy and into the official workforce is to raise wages. And that's simply not happening, nor likely to. Cutting interest rates might be nice temporarily for the stock market but does nothing to boost wages.

Bottom line—it's altogether possible that despite the yield advantage, albeit a contracting one, the dollar loses its status as top dog because of Trump. Confidence in the system that issues a currency is a necessity. The dollar is not like any other currency in the world because of its reserve currency and trade numeraire status. Trump is in the process of destroying that confidence. We have been wondering ever since his election at what point sentiment against Trump would manifest itself. It has been ironic that the dollar thrives when the country's leader is incompetent. On the whole, markets ignore politics—until the politics threaten the status quo. We have that now starting to occur in the US... worse, the leader prefers a depreciating currency and says so. We are starting to think the dollar will have a hard time clawing back gains. We had thought the euro's upside breakout was a temporary thing, but not we are not so sure.

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