Monday, March 13, 2017

"Succinct Views of Ten Events and Market Drivers: Week Ahead"

From Marc to Market:
The week ahead is the busiest week of the first quarter.  It sees four major central meetings, including the Federal Reserve which is likely to raise rates for the second time in four months. The Dutch hold the first European election of the year, and the populist-nationalist party remains in contention for the top slot. The week concludes with the G20 meeting, the first that the Trump Administration's presence will be felt.  

Since the events are well known, we may be able to add the most value by sharing our expectation of the outcomes and significance for the capital markets.  The immediate backdrop is solid US jobs growth, heightened expectations of a hike, firm eurozone data, stabilization of the Chinese economy, capex and export-led expansion of the Japanese economy, and a pullback in commodity prices, including oil, after a run-up that carried over from last year.   Interest rates are mostly moving higher, and equity markets have been trading heavier after a strong start to the year.  

1.  FOMC meeting:  The combination of data and official comments spurred a sharp swing in expectations toward a rate hike on March 15.  There is no reason to think that the Fed will not deliver. This is taken as given now, and investors will be more interested in the updated forecasts (dot plot) and the context Yellen provides at her press conference.   While the last set of forecasts showed the median expectation (not a promise or commitment) that three rate hikes would be appropriate this year, the market is unconvinced.  It is discounting about a one in three chance that the Fed will deliver three hikes this year.  We suspect the market is underestimating the hawkishness of many regional presidents, some of whom will be emboldened by the resilience of the US economy as they have argued. To the extent that the forecasts are changed, we expect more dots to be raised.  We see the confidence of the Fed officials, seen in subtle shifts in their word cues, as indicative a different reaction function.  Previously officials needed confirmation that the recovery was resilient.  It has become convinced.  Now it is looking for appropriate opportunities.  A hawkish hike, as opposed to the past two dovish hikes, could support the dollar and spur bearish curve flattening (short-term rates rise more than long-term rates).  If the Fed statement, forecasts, and press conference fail to convince the market that a follow-up hike in June ought not to be ruled out, the dollar would likely sell-off, as stale longs move to the sidelines.  A rally in bonds would likely weigh on the dollar against the yen.  Rising yields are seen helping banks and other financial institutions.  A fall in yields may see some investors shifts into other sectors.  

2.  Dutch Election:  Judging by the developments in the credit markets, investors are not as worried about the prospect of the populist-nationalist forces winning that the media.  The fragmented nature of Dutch political parties requires coalitions, and this serves as the ultimate check on the Freedom Party and Wilders' agenda.  It will take some time to sort out the results and form a new government, which may entail the inclusion of four or five political parties.   The hubris of small differences may make it difficult to form a government in the first place or lead to a fragile government.  A stronger than expected showing for the Freedom Party (PVV), of say 26 seats (150-seat chamber) could elicit a market reaction, but in lieu of this, the market impact is likely to be minor.   The generally expected outcome that a new government excludes the PVV might encourage investors and observers to question the main narrative that populism-nationalism is sweeping across Europe and the US.  To the extent that the populist-nationalist agenda entered the governments in the US and UK was when the main center-right party adopted.  In Europe, the center-right parties are running against the populist-nationalist parties. 

3.  G20 finance ministers and central banks meeting:  No fresh initiatives can be expected.  The outlook for the global economy has improved marginally.  The most important change since the last meeting is the inclusion of the new US Treasury Secretary.  Many partisans fail to appreciate that the despite that there are two distinct economic wings of the Trump Administration.  There is protectionist, unilateralist (most definitely not isolationist), American-First wing.  It is facing off against a more free-trade wing that accepts the basic premises of the liberal global world order of the post-WWII era.  The G20 statement, and how the final version evolved from the preliminary leaked version may occupy analysts and journalists, but investors will likely file it with the "good to know" rather than an inducement to act.  

4.  Before the G20 meeting, there are two US-German meetings that will draw attention.  German Chancellor Merkel will meet Trump in Washington, and Treasury Secretary Mnuchin will meet Schaeuble, his counterpart in Germany.  Over the past year or two, the US Treasury Department's  semi-annual reports on the international economy and foreign exchange market have become more critical of Germany.  In the early days of the Trump Administration the line has been pushed more forcefully.  There has been a striking juxtaposition of roles.  Merkel has defended the liberal global order against the threats to it by American protectionism.   Traditionally,  Americans often saw Russia posing a greater threat than many Germans.  Now Merkel is trying to keep sanctions in place of the seemingly more accommodative Americans.   Mnuchin appears to be part of the free-trade wing of the Trump Administration and will likely get on well with Schaeuble.  They can commiserate over the soft money policies of the ECB and the bureaucrats in Brussels.   The market impact may be in inverse proportion to the news coverage.  The more talk, the less was done....MORE