Politics Not Economics is Driving the Markets

Politics, Not, Economics, Driving, Markets, Macroeconomics, US dollar, FED, Yellen, fx trader, forex

08 Feb 2016

The US dollar has been correcting lower since mid-December. Interest rates have begun moving in the dollar's favor, and the equity market is again knocking on record highs. The US economic data, coupled with Fed comments, keep the Fed on track to hike rates.

Even with the weaker than expected wage growth in January, investors saw a greater chance of a June hike. Yellen has warned of a "nasty surprise" if the Fed waits too long, and even the dovish Chicago Fed President Evans seems endorsed two, and possibly three hikes this year.

This year is different than 2015 and 2016 when the Fed hiked rates in December both years. The Fed is more confident of the underlying resilience of the economy and more sure that price pressures will continue.  In December, the FOMC statement said that "...inflation is expected to rise..." Last week the FOMC statement said that "...inflation will rise..."

The five-year breakeven (conventional yield minus the yield on the five-year inflation protected security) closed above 2% for the second consecutive week. A year ago it was a little more than 1%. The 10-year breakeven has closed above 2% for four consecutive weeks. It is approaching 2.10%, the highest since September 2014.

The US economic calendar turns lighter next week. However, after a disappointing first estimate for Q4 16 GDP, the typically more conservative NY Fed GDP tracker is pointing to 2.9% growth in the current quarter. The Atlanta Fed sees the economy tracking 2.3%.

The unpredictable nature of the new US Administration, and its seeming willingness to antagonize allies and rivals alike, and making arbitrary judgments, appears to have increased the uncertainty. Although Administration officials articulate pro-growth sentiment, there is a concern that other policies will undermine the investment climate.

Still, as the Trump Administration begin turning its attention to its economic agenda, investors' confidence may be bolstered. Already a group of large exporters, including GE, Boeing and Oracle are forming a lobby to support the border tax. The executive order to review Dodd-Frank signed before the weekend, send the S&P 500 financial index up 2%, with several of the large bank shares rallying the most in three months.

However, the focus seems to be on parts of the legislation, like the Volcker Rule that curbs proprietary trading by banks, which were seen a conflict of interests and encouraging risk taking that is ultimately backstopped by taxpayers' money. Also, the fiduciary rule, which forces financial advisers to put client interest first in managing retirement savings, has also incurred the wrath of the President. These are not the kind of things will help Trump's supporters or broaden his base.

The vice-chair of the House Financial Services Committee sent a pointed letter to Federal Reserve demanding that it ceases and desist from continuing to participate in multilateral financial regulation negotiations, including the Financial Stability Board. The letter is not from the chair of the committee or President Trump. Nevertheless, it is important, and the Federal Reserve will respond, perhaps in the days ahead. Yellen will deliver her semi-annual testimony to Congress in the middle of the month, and this will likely be a key topic. Like other positions Trump is staking out, the claim that US participation in global regulatory efforts is undermining US growth has been made for several years by top US bankers, including JP Morgan's Jamie Dimon.

Given the recent ECB and BOE meetings and preliminary estimates for Q4 16 GDP, data from December are unlikely to move markets. Investors seem to focused on three things: Brexit, European elections, and the sharp rise in European interest rates and expanding premiums over Germany. UK Prime Minister May is widely anticipated to formally trigger Article 50 next month and begin the two-year negotiation process. Meanwhile, the next month's Dutch elections are not drawing the same attention as the French election even though the populist-nationalist forces seem stronger.