Pressure on Trump rises

Investigation of ties between President Trump's campaign and Russian officials should trigger further volatility

The acceleration of the affair about ties between Donald Trump's campaign and Russian officials has triggered varying reactions on financial markets; however, the reactions were muted overall. The whole issue gathered pace after Donald Trump surprisingly fired FBI Director James Comey on May 9. The most recent climax was the appointment of Robert Mueller as special counsel for the investigation, with far-reaching powers. For example, Mueller is absolutely independent and not subject to any orders.

The strongest reaction so far was shown in the EURUSD exchange rate. The euro reached its strongest level since the election of Trump. Good economic data coming out of the Eurozone also likely played a part on the euro's firming. But political events in the US had undeniably the strongest impact during the last days. During the last week alone, the euro strengthened vs. the dollar by more than two US cents. On the treasury market, longer-term maturities reacted the most. The reason being that it could become increasingly harder for a politically-damaged president to implement his agenda, namely the promised tax cuts. The outlook for tax cuts was the main reason why yields rose strongly after Donald Trump's election in November. At the same time, the fact that yields declined only moderately in recent days shows that previous political events had already decreased market expectations for tax cuts. On the other hand, the markets do not see the recent news as likely to have an impact on the Fed's monetary policy. The priced-in likelihood of a rate hike in June remained above 90%, only dropping for one day to about 80%. Equity markets only reacted most recently to the appointment of Mueller and the indices declined. The price of gold rose, on the other hand, but still remained clearly below this year's highs seen in mid-April.

Currently, it is hard to predict how the whole affair will evolve. The appointment of a special counsel is a clear indication that the scope of the investigation will be comprehensive and will take time. The mandate of the special counsel has no time limit.

We therefore expect any news relating to the issue to continue to trigger market volatility. Next week, for example, James Comey has been invited to testify in front of the House Oversight Committee on May 24, which will investigate whether President Trump tried to interfere with FBI investigations concerning his former national security advisor, Michael Flynn. It is currently not clear whether Comey will attend.

The whole affair quite clearly still has the potential to grow bigger. However, the impact on financial markets should remain contained to relatively short-term swings, in our view. Any lasting impact seems unlikely for us, as the affair is highly unlikely to alter the solid course of the US economy.


EZ – will the spell of fine weather continue in Eurozone's industrial sentiment?

The first flash estimate for the manufacturing PMI of Germany, France and the Eurozone will be released next week (May 24). The Eurozone's industrial sentiment has been flying high for several months, especially in Germany. In April, sentiment even climbed to a six-year high. However, this optimism has not been reflected in the 1Q17 industrial production data; compared to 4Q16, industrial production remained static. At the country level, developments were diverging. While Germany's industry production increased by 1% compared to the previous quarter, industrial production in France shrank by 1% in 1Q17.

In light of the dynamic development of sentiment in recent months, we expect no further improvement in May. The example of France also shows that good sentiment is currently no guarantee of dynamic growth (the French economy grew at below-average levels, with +0.8% y/y in 1Q17). Nevertheless, the economic outlook for the Eurozone remains positive in our assessment. The growth dynamic of German exports probably rose further in 1Q17. Considered from a historical point of view, the dynamic of German exports has been an important economic stimulus for other major countries in the Eurozone like France or Italy. However, the euro's latest relative strength compared to other currencies represents a slight downside risk for the export prospects of the Eurozone. On the other hand, the relative strength of the euro is also signaling increasing trust on the part of global investors in the economic perspectives of the Eurozone, as they are obviously willing to invest their money in Europe. At present, we expect GDP growth of +1.8% y/y in the Eurozone in 2Q17.

In Emerging Markets, the pleasant economic development also continues. The relative strength of Emerging Market currencies persisted in May, indicating ongoing capital inflows to Emerging Markets.The IIF estimates capital inflows corresponding to approx. USD 100bn so far in 2017. Even commodity prices, which are vital for economic development, again recorded gains after a weak phase in recent trading days. Positive development in Emerging Markets is important for the outlook for Eurozone exports.


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