Risk aversion causes fatigue

Outlook:

The world is worried about Trump's ability to rise to the geopolitical challenges thrown at him in the first 100 days. Every president gets provocation from some hostile party at the start of his administration. After the travel ban and health care bill debacles, not to mention the FBI investigation into Trump campaign connections to Russia, Trump has a tough row to hoe.

Yesterday Trump tweeted that if China doesn't help with North Korea, the US will "solve the problem alone." Pres Xi is reported to have telephoned Trump to tell him to resolve matters peacefully.

And Sec State Tillerson told the Russians to abandon support for Syrian president Bashar al-Assad, whose reign is "coming to an end." Nobody knows what the means, but this morning the WSJ front page headline is "Moscow warns Tillerson: No More Airstrikes in Syria." Russian Foreign Minister Lavrov "accused Washington of offering ‘ambiguous as well as contradictory' ideas about its stance toward Russia and foreign policy, and knocked Mr. Tillerson for having few officials in place at the State Department."

As noted above, geopolitical jitters causes a ruckus across all asset classes. The dollar/yen fell below the magic 110 level for the first time since November. Changes in nearly every asset price end up with a comparison to prices around election time—gold and VIX in particular, two key risk measures. Most of all, the 10-year yield closed at 2.298% and on an opening gap. Market News writes "On Friday, U.S. yields broke below an important support zone of old lows from late November, January and February, in the 2.29% to 2.32% zone, to post a low of 2.282%.

"A sustained break below 2.29% in U.S. Treasury yields would target the Nov. 17 and Nov. 15 lows, near 2.187% and 2.184%, respectively, and then the Nov. 10 lows near 1.991%. Ten-year yields have closed above 2% since mid-November. For bond bears to feel more confident in their view, ten-year yields will need to get back above 2.45%. The 100-day moving average comes in at 2.433% and is con-verging with the 55-day moving average, currently at 2.441%."

The WSJ reports geopoltiical factors "... have driven many bets on higher yields, known as short bets, to unwind over the past weeks. Selling Treasurys has been a highlight of the Trump trade since the U.S. election, with investors betting that large fiscal stimulus would lead to stronger growth and higher in-flation. One leg of the Trump trade, betting in higher inflation, pulled back further Tuesday. In doing so, they sold Treasury inflation-protected securities, or TIPS, and bought back Treasury debt. This con-tributed to the slides in Treasury yields.

"The 10-year break-even rate, the yield premium investors demanded to hold the 10-year Treasury note relative to the 10-year TIPS, was 1.89 percentage points Tuesday. That suggests investors' expectation of a 1.89% inflation rate over the next 10 years, marking the lowest such reading since Dec. 19. The break-even rate has been falling from its recent peak of 2.07% set in late January."

In sum, there are really two ways in which loss of confidence in Trump or fear of Trumpian ineptitude are harming markets—the possibility of war and diminishing hope for the Trump reflation trade.

Eeek! This is too much uncertainty (and unpredictability) to bear. Here's the thing about risk aver-sion—it can't be tolerated for long. Risk aversion causes fatigue. Traders can sustain fear just so long before they become tired of it, literally. The search for perspective tends to foster a pause and often a pullback-within-a-pullback. It also tends to foster side-stories. It's more tolerable to look at some less scary event than the central super-scary event. Today we'd guess the less-scary event is the French election.

Yesterday the Ifop Fiducial daily tracking poll indicated LePen will win 23% of the first round vote on April 23, with 23% for Macron and 19% for Fillon. Far-left Melenchon has been climbing rapidly and now gets 18.5%. The final outcome on May is still that Macron will win over LePen, by 58.5% to 41.5%. But what if it's Macron vs. Fillon or LePen vs. Fillon or (gasp) LePen vs. Melenchon? We know we can't trust polls.... The last option, LePen vs. Melenchon, would trash the euro. Both candi-dates want Frexit.

Bloomberg reports "The cost of hedging against declines in the Euro Stoxx 50 Index has surged to its highest level since June's Brexit referendum as investors race to protect gains before the first round of the French presidential elections. A gauge tracking volatility expectations for equities has also climbed for 10 straight days, the longest streak since November."

This is more fun than thinking about Trump. But unless we get outright war, the US economy is sturdy enough to keep on trucking. Besides, the possibility of something Good happening is not zero. Traders could latch on to some favorable news event and inflate it to the moon. For example, the NYT re-ports "a Chinese state-run newspaper warned the North that it faced a cutoff of vital oil supplies if it dared test a nuclear weapon." Maybe China is going to control its client state, after all.

Or instead of a pro-dollar political event, we could get a pro-euro positive event. The probability of a populist, pro-Frexit leader in France is less than 50/50, at least so far. If Macron wins the first round, as expected, the euro should benefit.

We can imagine all kinds of awful events developing, but in practice, a period of calm and nothing much happening can return markets to the status quo. So pray for nothing much happening. Otherwise, expect whipsaws.

Politics: If you want a weaker dollar, as we assume the Trump team does, one way to go about it is to stir up risk aversion so that yields fall. There are some plenty savvy guys from Wall Street in the administration and surely they know about this connection. This is not to say anyone is deliberately egging on the various parties to throw out confusing multiple possible policies, just that they can sit back and let White House incoherence do the job without lifting a finger. We would bet a dollar that once some actual deals get done, for example with China, Trump will pretend that sowing confusion left and right was deliberate—"don't show your hand, keep ‘em guessing."

It wouldn't take much to offset risk aversion getting such a strong grip. TreasSec Mnuchin could say something about tax reform plans. Commerce Secy Ross could say something about progress on the goofy private/public infrastructure plans. It's conceivable that after the health care bill debacle, the Trump gang worries about its credibility and doesn't want to test it. But to allow risk aversion on a messy foreign policy stance is not good for the public welfare, the public in this case being the financial markets.

They are falling down on the job.