The Challenging Week Ahead

<br /> The Challenging Week Ahead – Marc to Market<br />


The developments over the last few days,
including the strident tones of the inauguration speech,  the dispute of
the number that attended the inauguration,
and the nearly incoherent speech to the CIA may be a small hint to investors of
the unpredictable nature of the new US President. 
  The unorthodox style and rhetoric should not
distract from the necessary focus on policy.  Ultimately, public policies
and private sector behavior, not speeches or wishes, drive interest rates, equities, and currencies.   Investors will
have to get accustomed to the new Administration’s way of conducting itself and
With broad strokes, and recognizing some
contradictory impulses, at this juncture we suggest four main elements of
Trump’s economic policy.  
The first is re-writing trade deals.  This is a
central plank.  It is one of the key elements of Trump’s foreign policy
and job creation plans.   The potential of TPP being re-purposed as a
bilateral free-trade agreement between the US and Japan remains possible but unlikely.  
The priority
appears to be to re-negotiate NAFTA. 
 Few people are opposed to reviewing
old agreements.    No doubt it can be updated; it is 23 years old.
 Intellectual property rights have evolved, the Internet not only exists but is an important distribution channel
for goods, services, and information, there are new tax and accounting rules,
and the like. While modernizing old agreement is one thing, changing the
essential thrust (reduced barriers to
trade, in the North American continent) is quite a different thing.  It is
not clear to many whether Trump’s rhetoric is part of the “Art of the
Deal,” or whether it is a principled position.
Like his predecessors, Trump also talks
about enforcing existing agreements.  
 Sometimes there have been trade disputes among NAFTA countries.
 That is an important thing that is often
overlooked about trade agreements.  They provide a conflict
resolution mechanism; invaluable for resolving and containing disputes. It is
like a penalty in a football game or a
foul in basketball.  The violation of the rules is incorporated into the rules themselves.   
Remember too, the desire to negotiate
NAFTA (by Bush-the-elder, and approved under Clinton) was partly a reflection
of the significance of north-south trade. 
 In effect, the agreement codified and furthered
trends already in place, as well as a means to address infractions. The
agreement followed trade just as much as more trade followed the agreement.
Second, the White House says it wants the US
to create 2.5 mln new jobs over the next decade. 
Over the last five years, the US created an average of 197k net new jobs a month. The
five-year monthly average has rarely been over a 200k. Although during the
campaign there was talk of achieving
5%-6% growth, the White House now says 4%, while Mnuchin said 3%-4% in his
confirmation hearings.  
The US economy grew 3.5% in Q3, and the first estimate of Q4 will be reported on January 27.  The NY Fed’s GDP tracker sees growth
at 2.4% quarterly annualized rate (2.7% for Q1 17).  The median in the
Bloomberg poll is 2.2%, while the Atlanta Fed GDPNow estimate is 2.8% for
Third, tax code reform appears high on the
priority list. 
 The new Administration wants to cut
corporate taxes, simplify the code and reduce income taxes.  Although
there was some talk of reducing the tax rate on all income brackets, Mnuchin
seemed to rule out tax cuts for wealthy
Trump seems to have rejected the border
adjustment tax that the Congressional Republicans advocated, but taxing imports
(tariff) continues to be touted. 
 Trump promises deregulation
and new regulation have been frozen.  The Obama Administration
also froze new regulation at the very start.  
The fourth plank is the $1 trillion
infrastructure initiative. 
 It is important for jobs and growth,
though apparently not cited on the new White House website. President Trump did include it is his inauguration speech.
It is not clear the priority that will be given to filling the two empty seats on the
Board of Governors of the Federal Reserve. 
 It is possible that one of the
current Governors step down, we expected Yellen (and Fischer) to complete their
current terms.  Several regional Fed Presidents have already begun to
discuss reducing the size of the balance sheet, which seemed to have been an
issue for some economic advisers.  
Another important non-economic event that
investors will be monitoring is the UK Supreme Court ruling on whether
Parliament approval is necessary to trigger Article 50.  
After Prime Minister May’s speech last
week, the decision may have lost some of its ability to roil the markets. May
reassured that Parliament would vote on the final agreement.  
Although many in Parliament seem to has
some misgivings about the clean break strategy,  which had been thought of as a hard Brexit scenario,
there is little doubt a majority will vote to trigger Article 50. 
 The failure to do so would likely spark a political
crisis.  Northern Ireland will go to the polls on March 2.  An
anti-Brexit parliament could still frustrate May’s timetable, and Scotland
independence efforts may be fanned by the
UK government’s position.   It is also not immediately clear the
implications of the change in leadership of the European Parliament, which will
also vote on the final Brexit deal.  
The UK also reports the first estimate of
  UK growth has been remarkably stable. Quarterly growth has
averaged 0.6% over the last four and 12 quarters.  Quarterly growth has
averaged 0.5% over the past five years.  Economists expect the UK economy
grew 0.5%-0.6% in Q4 16.  
The US interest rate premium over the UK
has narrowed, and this appears to be
helping sterling find traction after the brief push below $1.20 at the start of
last week.
  The premium offered by the US on two-year money has fallen
below 100 bp from 120 bp at the end of last year. The 10-year premium has
fallen from nearly 125 bp to almost 100 bp.  Although the US premium over
Germany appears to have begun widening again, it has not spilled over to the
The eurozone
reports flash PMI and money supply.
  Germany reports IFO, and several
countries, including Germany, report retail sales.  Economic growth in the
eurozone, in aggregate, is not a problem.  It has been fairly stable and,
if anything, a little above trend.   The key issue is prices.  At last week’s ECB press conference, Draghi argued
that underlying price pressures remain muted. Despite the pop in headline
prices (1.1% in December from 0.6% in November), core inflation is subdued at 0.9% compared with the trough at
One of the concerns of policymakers and investors
is a problem with Italian banks.
  While this is still a work in
progress, we note that Italian bank shares have advanced in six of the past
eight weeks. More broadly, the bank sub-index of the Dow Jones Stoxx 600 has
fallen for the past two weeks and is off
five of the last eight weeks.  
Japan reports December trade figures and
 There is a strong seasonal component
to Japan’s trade balance.  Over the past 20 years, the December trade
balance has not improved over November only three times.  Exports appear
to have risen on a year-over-year basis for the first time since September
2015.  Imports are slowly recovering as well.  Excluding food and
energy, Japan’s CPI is expected to fall back below zero for the first time
since August 2013.  
The drivers of the yen seem clear, and it
is not the domestic economy per se.
  Rather the dollar-yen continues to
be driven by two attractors–US yields and equities.  On a purely
directional basis, the correlation between US 10-year yields and the dollar-yen
exchange rate is above 0.95 over the past 60 and 100 days.  On a percent
change basis, the correlation is at the upper end of where it has been since
the middle of 2014.  The correlation on a directional basis between the
Nikkei and dollar-yen and the S&P 500 and dollar-yen are also elevated.
 On a percentage change basis, the
correlations are not nearly as strong, of
course, but are at or near multi-month highs.  
Lastly, we note that the Australia reports
Q4 CPI figures. 
 The headline rate is expected to
accelerate to 1.6% from 1.3%.  Price pressures appear to be bottoming in
Australia.  A 1.6% pace would be the fastest quarterly increase in 2016.
  It was at 1.0% in Q2.  Rising price pressures appear to have
dampened ideas that the central bank may still cut rates.  The RBA meets on February 6 and rates will most likely
remain on hold.   Separately, Australia will report export and import
prices, and it appears the terms of trade are improving, partly with the help
of stronger iron ore prices.  

The Challenging Week Ahead
The Challenging Week Ahead

Reviewed by Marc Chandler

January 22, 2017

Rating: 5

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