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.
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.
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.
In the past few days there was news of Chinese banks restructuring bonds and tightening mortgage criteria to slow lending. US banks are also piling into ultra safe bonds and curbing lending throughout the year. Brexit has fractured loan availability across European countries, especially in Italy, including Germany.
Markets have not seemed to care, with market up from the years lows and only about 5% off the highs of the year. This should worry investors that in the medium term the lack of lending due to poor prospects could become self reinforcing and bring about the decline in economic numbers lenders are anticipating.
US election worries are front and center in the news, but after the election and the immediate smoke clears, markets will have to face year end and 2017 prospects. This is to include a rate hike that is still seen as more likely than not to be in December. The dollar has been rallying in light of that which is supposed to be a negative for the markets, but correlations have broken down throughout the past few weeks. the bond market is seeing yields spike from their summer lows on safe bonds, and even TIPS are getting a lot of attention. Market signals are looking like a rate hike is expected, while inflation will rise, and the economy continues to grow. All the while banks continue to buy more bonds and lend less. Hopefully the banks are waiting on the side lines for higher rates to start lending, but if they keep their purses tight, the economy will struggle to find the capital to keep its growth going.
The ECB rate decision is up and but the conference is where the action is going to take place. The markets are expecting policy to remain unchanged but the Language of the ECB will be of more concern to the markets. The fear is that the ECB is not doing enough to boost the growth of the Eurozone with an extension of the purchase program or additional stimulus measures. But the abilities of the ECB to take more stimulus actions are where the issues are starting to come forth.
The Eurozone has not been fully integrated with fiscal measures, and the guidelines of monetary policy are in a grey area at the moment. The problems that are slowing growth in the zone (low growth, high debt, high unemployment, etc.) need to be solved politically. With the rise in right wing politics across Europe and major elections across the continent within the next two years, very little is expected to come from the current political climate, possibly even less in the future.
It would be interesting to note in today's speech by Draghi if these needs for fiscal stimulus and political action are brought up. One thing is clear, that Draghi will have to continue to convince the markets that more measures can be taken to boost growth and inflation even without the help of the fracturing governments of the Eurozone.