Trump & The Future of the Dollar
Posted on: 30 August 2017 , by: Darren Sinden , category: Market Review
In recent weeks markets have had to contemplate the prospect of a possible nuclear conflict between the USA and North Korea. That threat appeared to have subsided, though a recent NK missile test has raised tensions once more.
But we have also seen a different kind of fall out settling over Washington DC.
That fallout is made up of the ashes of the Trump presidency. Events in Charlottesville and the President's refusal to condemn extremists and their actions have meant that Mr Trump has become increasingly isolated from the media, the public and perhaps most importantly the members of his own party in the US legislature.
“No man is an island,” they say, but the President is starting to look more and more like the modern day Robinson Crusoe, i.e. completely isolated. Business leaders resigned from White House advisory committees following the President's Charlottesville comments and in particular his lack of condemnation for the extreme right wing views of the protestors. Mr Trump's response was to disband the committees perhaps in an attempt to get ahead of the story as they say.
But in the end, his actions made him look like a spoilt child.
How the Trump White House reacts to flooding in Houston, caused by hurricane Harvey, may now help to define the presidency.
The US dollar has been the principal casualty of the political inaction in DC. But America's credibility on the international stage is now being called into question. Mr Trump's behaviour is more akin to that of an autocratic dictator than to the leader of the world's richest and most powerful nation. He can apparently not see the error of ways (or is unwilling to), and he seems to believe that it is his way or the highway. The problem with that attitude is that US politics is about building a consensus not just once but over every piece of legislation. To build such a consensus, you need the support of your own party members alongside like-minded opposition politicians and vested interests. Doing that from the top of an Ivory tower is impossible.
So what does this mean for markets?
US equity markets, which have risen to consecutive new highs over 2017 to date, had one of their worst days in 2017 on Thursday 17/08/17. The tech heavy Nasdaq 100 fell by -2.0 %, while the S&P 500 and Dow 30 were lower by -1.5% and -1.2% respectively, as they appeared to be becoming disillusioned with President Trump.
The Russell 2000 (US 2000) index, which monitors the performance of US small cap equities, fell by -1.8% and gave its year to date gains as a result. What's interesting here is that this broad based index has been trending lower since late July and during that time it has significantly diverged from the trajectory of both the S&P and the Dow.
This type of divergence is a potential cause for concern. The fall in the small cap index may not be related to events in Washington. But I'm inclined to think that this could be an early warning indicator of what could happen to large-cap stocks, should the situation in Washington become any graver.
US equity markets have recovered somewhat in the intervening period, but they remain vulnerable.
Catalysts for negativity could come in the shape of a failure to reach agreements over the US debt ceiling, the federal budget for 2018 or President Trumps much-vaunted tax reforms. Both the budget and a resolution to the debt ceiling issue are crucial if we are to avoid further disruption in Washington.
The worst-case scenario here would be a shutdown of some or all of the federal government until new money is forthcoming.
Tax reforms are not as critical, although tax revenues would, of course, form part of any budget. That said, a failure to reach an agreement and enact this flagship election pledge could well leave the Trump Presidency dead in the water. That could raise the prospect of three further years of legislative stalemate. This is not something that I believe US equity markets would immediately warm to. Given that we have had 8.5 years of a mostly uninterrupted bull market in US equities.
How does this impact the Dollar?
Any correction resulting from the above could be sharp and substantial. In these circumstances, money would likely move into traditional safe haven assets such as US bonds and the Japanese Yen. The chart above plots US 10 year Treasury yields (in green) against the Dollar Yen rate (in blue). As we can see, over the last two years, they have been closely aligned. If risk off were to become the flavour of the day once more, over the last three months of 2017, we could anticipate a sharp fall in US Treasury yields and jump in the value of the Yen. Which could see the Dollar Yen rate test back below 108 and perhaps down to the 100 level once more.
Note that US Treasury yields have fallen and the Yen has strengthened to 108.47 versus the Dollar, as of 11.00 am GMT on the 29/08/17, following North Korea's provocative missile test through Japanese airspace.
President Trump was elected as a "dealmaker", and the next few weeks may well stress-test the validity of that claim to the maximum. Problems in Washington mean opportunities for FX traders of course. Market sentiment and therefore prices have the potential to swing sharply in the coming weeks. We saw a similar process earlier in the year, during the administration's attempts to repeal or reform “Obamacare”. President Trump may surprise us once more (as he often did during the 2016 campaign) by starting to mend fences and reaching out to his fellow Republicans, once more. Though the old adage about Leopards not changing their spots springs to mind, perhaps pragmatism will prevail in the White House. In any event, the 12 weeks or so between Labor day and Thanksgiving could be the most important weeks of the year, as far as the markets and traders are concerned.
For more analysis, you can check out Darren's Daily Market Update (key market news in minutes).
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