Markets Little Changed as Breakout is Awaited

The capital markets are becalmed, and the US dollar is in narrow trading ranges. Month-end considerations are at work, but the key event is much-awaited speech US President Trump to a joint session of Congress this evening (early Wednesday in Asia). The hope is that he provides the policy signals that allow the dollar to break out of its recent ranges. The combination of fiscal stimulus and less accommodative monetary policy is thought to be dollar-friendly.

At the same time, given the build-up, the mercurial temperament, and unorthodox style could set up investors for disappointment, after the Dow Jones Industrials have rallied for a dozen consecutive sessions, and the S&P 500 off only three sessions this month, coming into today. The speculative long dollar position has been reduced in the futures market, but it remains net short euros, sterling, and yen. However, speculators are also net long the dollar-bloc currencies.

There seem to be several ways that expectations could be disappointed, but what they have in common is dampening of expectations for fiscal stimulus. Yesterday's call for a substantial increase in defense spending, while cutting discretionary spending may run into some difficulties getting around rules designed to avoid precisely that. In any event, the Trump's economic team appears committed to stronger US growth via trade adjustment, tax reform, deregulation, and infrastructure spending.

Although the Republicans hold both houses of Congress and the White House, its slim majority in the Senate denies it carte blanche. Also, some Republicans in Congress and some Republicans in the White House do not see eye-to-eye on the full range of fiscal issues. The comprehensive tax reform efforts are predicated on raising sufficient revenue to avoid or minimize the impact on the deficit and debt.

There are two main sources of revenue, in this approach. Taxes that are currently being used to fund national health care, for which opinion surveys now suggest greater for as it is about to be fundamentally altered, and the proposed border adjustment tax on imports. Between the two there is more than $2.0 trillion that theoretically can be used to fund tax cuts that in the dynamic accounting and optimistic assumptions can actually increase revenue. Both sources are not as solid is it may have appeared even a few weeks ago. The repeal and replacing of the national health care is turning out to be more complicated that officials understood, and the border adjustment appears not to have the necessary support in the Senate.

Trump speech is likely to be a broad wish list and then call upon Congress to deliver. He does not need to prioritize his programs. Treasury Secretary Mnuchin said last week that the infrastructure initiative is more a 2018 story, but yesterday Trump pressed this issue. Nevertheless, it does not seem that fiscal policy will be a major factor in the Fed's decision in two weeks about raising interest rates.

The market increased the odds of a March hike yesterday. According to Bloomberg, the Fed funds futures contract has discounted a 50% chance of a hike, while its calculation using the overnight index swaps (OIS) is 57.1%. The CME, where Fed funds futures trade estimates the probability of a March hike at 31%.

The news stream is light. Japanese industrial output unexpectedly fell in January, for the first time since last July. The 0.8% decline contrasts to expectations for a 0.4% increase. The January decline comes after rising of nearly the same magnitude in December (0.7%). Australia reported a smaller current account deficit in Q4 (A$4.0 bln from Q3 revised A$10.2 bln (which could have a small knock on effect on expectations for tomorrow's GDP report.

Preliminary French and Italian inflation figures were reported, and they moved in opposite directions. Italian CPI rose 0.2% in February. The Bloomberg median estimate was for a 0.1% decline. The year-over-year rate rose to 1.6% from 1.0%. France's estimate rose 0.1% rather than the median estimate of 0.4%. The year-over-year rate slipped to 1.4% from 1.6%.

In terms of economic data, the US session features a likely upward revision to Q4 growth to 2.1% from 1.9%, helped in part by better consumption. The preliminary merchandise trade balance for January will be reported at the same time. The wholesale and retail inventories will be reported too and may be overshadowed by the other data. Later will be house price, Chicago PMI and the Conference Board's consumer confidence measure. The Fed's Harker and Williams speak toward the end of the session, while Bullard speaks a couple of hours before the President.