June 11, 5:00 pm EST
Last week we stepped through all of the components of economic output and talked about the setup for positive surprises. Keep in mind, the economy is running at near a 3% pace already. And if Trumponomics is just in the early stages of materializing in the data on consumption, investment, government spending and exports, then we may be in for a big growth number.
On Friday we talked about the exports (i.e. the trade) component. On that note, the media was stirring over the combative tone from G7 events over the weekend. What I heard was the potential for big movement (i.e. gains on U.S. exports, which will drive gains in GDP). Trump went in and proposed taking down all trade barriers. That’s negotiating from an extreme. And that typically brings about movement. Quickly, trade partners were discussing “reducing” barriers.
With hotter than expected growth coming, how will that effect Fed policy?
We will soon see. The Fed meets this week. They continue their path of normalizing rates. They’ve hiked once in 2015, once in 2016, three times in 2017 and once, thus far, this year. The market is nearly fully pricing in a second hike for the year on Wednesday. And expectations are for another hike in September. We’ll see this week if they’re adjusting uptheir growth forecasts.
As for the rate path: Remember, Powell is a Trump appointee, and from what we’ve heard from him thus far, he sounds like someone that’s not going to risk chipping away at the recovery by jumping ahead with overly aggressive rate hikes. Unlike the last regime, he will likely take a “whites of inflation’s eyes” approach.
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This will be an interesting week. We had almost three months of optimism priced into global markets following the November 8th elections. And then the tide turned when Trump gave his speech to the join sessions of Congress.
This is the buy-the-rumor sell-the-fact phenomenon we’ve discussed. People bought on anticipation of a big policy shift. And now they’re taking profit (raising cash) waiting to see it all executed — the prove-it-to-me phase.
I think we’re beginning to see the same phenomenon unfold in the Brexit saga. Brexit came before Trump, but the cycle has been slower and longer. Much like the Trump trend, the Brexit news started with an initial “sell everything” on the fear of the unknown, but soon thereafter, the “buy on anticipation of something better” prevailed. But it’s looking very vulnerable now to a turn in the tide.
On Friday, we looked at this next chart. This trend higher in UK stocks looks much like the Trump trend in U.S. stocks – a nice 45 degree climb from June of last year.
But as we discussed on Friday, the “prove-it-to-me” phase looks set to arrive this week in the Brexit story. With that, here’s what the chart looks like today …
This nine-month trend line in UK stocks gave way today – in part because of the softening in expectations about Trump policies, but largely because the UK Prime Minister is expected to officially notify the European Union on Wednesday, of the UK’s exit from the EU. Again, this would start the clock on the two year wind-down of the UK constituency in the EU. And the official negotiations will begin, on what the UK/EU relationship will look like – namely, on trade.
Expect the negotiations to be ugly in the early stages. Why? Because there is a lot to lose if it looks too easy. The future of the European Union and the common currency (the euro) hang in the balance on these negotiations. The most important job of EU officials, at this stage, is keeping other EU members from hitting the eject button, following the lead of the UK. A domino effect of exits would kill the EU and it would be the end of the euro. And that would have huge, destabilizing global ramifications.
With all of this in mind, it’s very likely that after long period of ultra-low volatility in markets, things will be a little more dicey in the months ahead. That should keep pressure on yields and should keep the correction in U.S. stocks intact.
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