With the Fed minutes today, we are seeing more evidence of the policy and inflation being intertwined. The Fed mentioned that while markets are looking at lower taxes and more fiscal expansion, it is difficult for them to asses the inflation levels that will come through 2017 and beyond. The minutes have shown the vast majority of Fed officials wanted more information on the policy front before taking action in January.
It will be interesting to see if inflation expectations create a self fulfilling cycle and the Fed is forced to raise rates into an environment that doesn't see fiscal stimulus come. This would no doubt see a re-pricing in the markets, specifically commodities and emerging markets which are participating in this broad rally perhaps unjustly.
On the other side of the spectrum, which the minutes seem to have alluded to, is the Fed holding back on rates due to the uncertainty. This could cause inflation to get ahead of the 2% target and see the Fed either have to aggressively increase rates, shocking the markets, or being seen as behind the curve. This could explain the rise in gold along side the S&P500 along side the markets in 2017.
The Dollar is down to the pound and euro from better than expected inflation numbers out of the UK and upbeat remarks from the ECB. In about 30 minutes Theresa May is set to outline her Brexit plans which could send the pound back in the other direction.
We have seen the inflation pick up in many regions that were plagued with slow growth and low inflation since the crisis, which has allowed the Fed to raise rates and the look to do so more aggressively this year. But the political landscape it talking about some policies that could derail these early signs of normalcy.
The hard Brexit speech coming up within the hour will be the first we can see the headwinds that the UK might face over the coming years and how this will affect growth.
Chinese President Xi Jinping has also make some strong comment at the World Economic Forum in response to Trumps trade talks. The rhetoric isn't the main reason for concern, but the fact that Xi is at the forum is a sign that China looks to take a more active role in the global economy. If America starts to isolate itself now it will be ceding regional power and economic potential to countries that are looking for a more outward role.
Through this week's inauguration and the months beyond we will see if the politics of the Eurozone, UK, and US will have the same effect that the November elections did for the reflation trade or if the skepticism of trade and globalization start to pull back growth expectations.
Eurozone inflation numbers came out higher than expected which gave the ECB signs that their stimulus is working. The bank now believes they will reach their goal of 2% inflation by 2019. While this is a welcoming sign of the Eurozone returning to normalcy Germany might not be as welcoming to staying the course to 2%.
Inflation in Germany is out pacing that of the greater Eurozone, the government will have to make a choice to absorb higher inflation for the greater good of the Eurozone, or push for a dampening of stimulus. What Germany decides is an important part of the equation because their lack of leadership in the fight to stem inflation will prevent the transfer of the debt burden off of the southern countries to the bond holders (namely Germany). Failure to do so will create a greater rift in the two speed Eurozone recovery and put strains on periphery budgets and growth.
It will be interesting to watch the Euro and how it reacts to news of Germany not willing to accept more inflation for the greater Eurozone. What should come to strengthen the currency through a more unified economy would start to unravel, with talks of a t class euro and Germany or other leaving the bloc starting to pull the currency down. Spreads on Eurozone debt will also tell the story, with a rise in German Bunds narrowing the spreads with other countries being a sign of markets feeling the country is in lockstep with the measures taken by the ECB.
Markets are starting a new year. The US markets look to be opening higher, oil has hit a high not seen since the middle of 2015, and the dollar is rallying. The news is talking of a lot of the news that could de-rail the current rally, and while there is merit to it the factors to watch can be boiled down to a few data points.
Today the Fed will most likely raise rates. The markets have priced that into near certainty. What is more important is the message that will come after the increase. The Fed's reaction to the 'reflation' trade spurred by a Trump victory is making assumptions of higher growth and inflation rates in the future. This trade has put the markets at record highs in the US and saw the price of gold driven down by a rising dollar and higher rates in the bond markets. What will determine the trajectory of gold in the coming year will be dependent on the message the Fed delivers.
If the Fed gives into the reflation trade and talks aggressively on inflation threats on the coming year the price of gold will suffer more. The yield curve will flatten as rate increases look to dampen the longer term inflationary prospects of the U.S economy. The more likely case is that the Fed will wait to see if this rhetoric will come to fruition in the coming year and keep an eye on inflation numbers through the first half o next year. If and when fiscal stimulus legislature gets passed you could expect to see more concern from the Fed. In this case the threat of inflation going higher than the nominal GDP rate could spur a drop in the dollar and a rally in gold as a hedge against the potential if negative real rates.
The Italian referendum gave a shock to the markets, for all of about an hour. Since the referendum the PM resigned and opened the potential for a euro-skeptic to take control in future elections. To date there doesn't seem to be much concern in the markets over the threat to the Eurozone but the seeds of a crisis are sown. The far right policies in France, Italy, and even growing in Germany will make cohesive action around the next crisis almost impossible. This will lead markets to see this as a fragmenting of the markets and yields on bonds across the region will start to diverge much more than they have now. Germany will not be exempt from the pain, if investors start to price in more of a likelihood that countries such as Italy will leave the Eurozone, inflation expectations will increase dramatically and cause the ECB to take a second look at their stimulus program.
These policy issues put more of a strain on toolkit to resolve issues and not necessarily cause the problems themselves. So the markets could continue their accent for the time being but any rise from here will be without much of a safety net for future issues that may arise.
Italian election results did not sway markets for long. Indices rallied back with the US market having an early morning rally. The Euro was down over a percent after the results to stage a rebound to 70 bps higher on the day. What does this all mean in market terms? Bad news, or the perception of bad news, does not last in the markets long and is seen as an opportunity to buy. With the Fed meeting a week away and markets expecting a rate hike, it is not hard to see more upside in the month ahead.
It is hard to predict where market changing sentiment will come from. One place to look out for danger is in the bond market. With yields increasing on treasuries and corporates, the competition to stocks is increasing. The melt up in the stock market is keeping equities attractive for the time being but any lateral movement or downside could be an opportunity to put gains into cheaper bonds (giving a higher yield). Seeing yields start to level and capital go bargain hunting could be a sign that investors feel bonds have met the inflation expectations of the future.
Combine the higher yields will make it harder for stock to borrow and make their future earnings in the future less, you will have a good trade-off in stocks to bonds. The spring is being coiled for bonds to have a rebound after these losses. All we are missing is the right level and a push from an external factor to set things in motion.
The S&P 500 hit a record intra-day high today, also breaking a major technical resistance level. This shows more upside in the US markets, all things remaining equal. But it would be wise not to look away from the rest of the global economy. The US election has captured the headlines and attention of markets and will be a formidable force in markets for some time.
Italy is going to have their Referendum in 2 weeks time, which could be another blow to the unit of the EU in budget balancing. The EU is already facing populist factions that want to have their own 'Brexit' moment, and a lot of the resentment is a byproduct of low growth.
China has restricted lending to real estate developers, which is starting to be seen in the home numbers, and soon GDP. How well the Chinese government manages the decline in home prices will have a larger impact on commodity prices than any type of stimulus plan or inflation trade that may come to fruition in the new administration.
The optimism in the US is hard to ignore, let alone short, but it is more important now to look at external factors to be the 'out of left field' news that shakes the mood in the US.
A surprise Trump victory in the US cause overnight market turmoil. US futures were down 5% as the results started to show Trump taking the lead. We have now gone 50 bps positive on the S&P and markets seem to have shrugged off all of the fears that caused the market declines last week.
Looking longer term I wonder how much of this is attributable to the expectation of easing by the Fed as a result, short covering, or cash coming back in after the uncertainty cleared. This week could be an opportunity to look positioning for the road ahead in 2017 and what factors could shape perception.
This week started out with an early example of how much the markets will dictated by US elections. With news that the FBI stood by its previous decision to not charge Hillary Clinton over her E-Mails, markets have spike considerably. The Dollar has also gained some ground. This goes to show the amount of volatility that will be seen in the next couple of days, not to mention after the results of the election.
The results of the election could move markets significantly, especially with a Republican win of Donald Trump. This will be due to the uncertainty that a Trump presidency will bring, look at the reaction of the Mexican Peso as a clear example of market participants ebbing and flowing around this prospects. But more importantly is to look longer term, into the next year, where the markets have not been too busy to look. There will no doubt be winners and losers in the immediate aftermath of the election, but how does the next year look in terms of global growth, politics in Europe and Japan, and Debt concerns in China.
The election could change the market paradigm, but if we get the status quo, markets will look to a new paradigm. Many pundits and hedge fund managers are talking about the valuations of the market being too high or having room to grow. The reality of the market's current valuation will be judged from the view of the landscape after the fog of the election is gone.