Talk of return of the ‘Trump trade’ is seriously misplaced
The sudden rise in the dollar index and Treasury yields stems just as much, if not more, from the more hawkish stance of the Federal Reserve
Last Thursday, the benchmark American S&P 500 stock market index enjoyed a sixth consecutive record close for the first time since June 1997 while the Vix index, Wall Street’s so-called fear gauge which measures the anticipated volatility in the S&P 500, fell to an all-time low of 9.1 points.
The same day, President Donald Trump, whose administration is mired in scandal and which has suffered a string of high-profile legislative failures, fired off one of his customary self-congratulatory tweets in which he boasted: “Stock market hits an all-time high! Unemployment lowest in 16 years! Business and manufacturing enthusiasm at highest level in decades!”
It is not surprising that Trump is eager to take credit for the renewed rise in the S&P 500 – the index has risen more than 5 per cent since mid-August – given the extent to which confidence in his pro-growth policies of tax cuts and infrastructure spending, which fuelled the “Trump trade” in the months following his election victory, has plummeted.
Having shot up at the end of last year as international investors positioned themselves for a sharp rise in inflation and growth, the dollar index (a gauge of the greenback’s performance against a basket of other currencies) and the 10-year US Treasury yield, the two key reflation trades, fell sharply between March and the end of August.
Yet since the start of September, there has been increasing talk that the Trump trade is making a comeback.
The dollar index and the 10-year Treasury yield have risen 2.5 per cent and 35 basis points respectively to their highest levels since mid-July. Just as tellingly, emerging market assets, which have benefited significantly from the fizzling out of the reflation trade, have come under renewed strain. According to JPMorgan, in the week ending October 4, emerging-market local currency bond funds – which are highly sensitive to movements in the dollar – suffered their largest outflows this year.
The sudden reversal in the direction of the dollar and Treasury yields stems partly from Trump’s long-awaited announcement on September 27 of a sweeping plan designed to slash America’s official corporate tax rate from the current 35 per cent to 20 per cent and, just as importantly, end the taxation of companies’ non-US earnings.
While the details of Trump’s tax proposal are sketchy – it is unclear whether the cuts will be fully paid for or will increase the US fiscal deficit further – and it remains to be seen whether the president’s Republican party can unite behind the plan, investors have taken note.
John Authers, the investment commentator of the Financial Times, rightly claims that as recently as early September “the markets’ collective judgment was that the chance of a significant tax cut this year was close to zero.” Now “markets are moving to price in the chance of a tax cut once more.”
But does this signal a turning point for global markets? Not necessarily.
The sudden increase in the dollar index and Treasury yields stems just as much, if not more, from the more hawkish-than-expected stance of the Federal Reserve. The US central bank’s decision on September 20 to start unwinding its US$4.5 trillion balance sheet this month and stick to its forecast of four more interest rate increases by the end of next year has pushed up bond yields and the greenback. US financial stocks shot up 8.5 per cent last month as the policy-sensitive 2-year Treasury yield surged to 1.5 per cent – its highest level since 2008.
But even when it comes to the Fed, investors remain sceptical about the scope for further monetary tightening. While bond investors are pricing in a 90 per cent chance of another rate increase in December, they are much less certain about the policy outlook for next year. This is mainly because of growing anxiety in markets about the new leadership at the Fed.
If there is a Trump trade right now, it is the intense speculation about whether he will reappoint Janet Yellen as Fed chair once her term ends in February or replace her with a more dovish successor committed to keeping rates low and easing the regulatory burden on banks.
If investors believe US monetary policy is being politicised – there are three other vacancies on the Fed board for Trump to fill – the dollar could start to weaken again.
Bank of America Merrill Lynch notes that “markets are reluctant to trust the dollar again.” Investors are even warier of putting their faith in Trump again.
Talk of a return of the Trump trade is seriously misplaced.
Nicholas Spiro is a partner at Lauressa Advisory