The Daily Prophet: Trump's Dollar Sending Some Worrisome Signals

Connecting the dots in global markets.

In a matter of only a few hours, foreign-exchange traders went from talking about how the worst may be over for the dollar to talking about how the worst may be yet to come. America’s currency was looking like it was starting to gain some traction this month after falling 9 percent this year through July as measured by the Bloomberg Dollar Spot Index. Then came Wednesday afternoon.

The gauge gave up its gains and fell the most since July 28 on news that more business leaders were leaving strategy and manufacturing advisory groups set up by Donald Trump as the president faced blowback for failing to sufficiently condemn white supremacists. The selling picked up steam as Trump announced on Twitter that he was disbanding the two groups. And if that wasn’t enough for one day, minutes of the Federal Reserve’s last policy meeting then showed that “many” saw some likelihood that "inflation might remain below 2 percent for longer than they currently expected.” Taken together, the currency market is signaling that the U.S. economic outlook is suddenly very uncertain. Disbanding the White House advisory groups may make it tougher for the Trump administration to fulfill its pro-business, pro-growth agenda. That could weigh on the economy. As Carlos Gutierrez, the former secretary of commerce under President George W. Bush, put it to Bloomberg Television’s David Westin, “The honeymoon is over” for Trump.

The bond market certainly agrees with that assessment, as demand for Treasuries only got stronger throughout the day even though the Fed’s minutes suggested the central bank is still on track to start shrinking its $4.5 trillion balance sheet this year. The odds of another rate hike before year-end dropped to 36 percent from 40.4 percent Tuesday, according to data compiled by Bloomberg. Growing dissent among Republicans and tumbling support from the business community provide strong evidence that Trump will find it increasingly difficult to advance his economic agenda, according to Bloomberg Intelligence chief economist Michael McDonough. A post-election surge in enthusiasm by U.S. consumers has already begun to fade, McDonough wrote in a research note. Republicans and Democrats can both agree that the U.S. economy is in dire need of infrastructure investment to prepare the economy for the future and comprehensive tax reform to increase competitiveness, but as Trump continues to lose focus on these points, it’s the U.S. economy and the American people who are set to lose, according to McDonough. 


Although stocks came off their highs for the day, there was no sign of panic. For the time being, stock investors are choosing to put their faith in strong earnings underpinning high equity valuations rather than anything that might be coming out of Washington. Profits in the S&P 500 just posted two straight quarters of double-digit growth for the first time since 2011. Although valuations stand at levels not seen since the dot-com era, stocks are cheap relative to bonds with yields hovering near record lows, according to Bloomberg News’s Lu Wang. According to Wang, it’s not that the market approves of what’s going on. It’s just that it doesn’t care, said Paul Zemsky, chief investment officer at Voya Investment Management. “Unless we see concrete policy out of the administration, good or bad, the market isn’t really going to react to it because they’ve been fooled so many times,” said Zemsky, who helps oversee $213 billion. “When the fundamentals are good, staying out of the market is risky.’’ That was on display last week, when about $500 billion was erased from global share prices over three days after Trump said North Korea’s nuclear threat to the U.S. will be “met with fire and fury.” Most of that damage has been repaired, with the MSCI All-Country World Index sitting two points from its closing level on Aug. 4.

Citigroup is very worried about the massive inflows into emerging-market exchange-traded funds. After attracting almost $47 billion of new cash this year, Citigroup is concerned that ETFs have made developing nations more vulnerable to sudden outflows, according to Bloomberg News's Natasha Doff. The “ETF-ization” of emerging markets has made ETF flows themselves "increasingly representative of asset class sentiment as a whole,” Citi analysts Luis Costa and Toller Hao wrote in a research note. “If the tide turns, this strong positive directionality towards passive investments and ETFs can turn into a negative directionality.” The analysts’ unease echoes similar warnings from Bank of America Merrill Lynch and Schroder Investment Management, which cautioned last month that a pullback from emerging markets similar to the “taper tantrum” of 2013 would be exacerbated by the increased share of ETFs in the market. The $244 billion invested in emerging-market ETFs is about 19 percent of the total invested in emerging-market mutual funds, according to Citi. Costa and Hao note that ETFs and other passive funds had grown in popularity against more active managers, thanks in part to a long spell of low yields and volatility. “In a very paradoxical way, not all kinds of investors benefit from long lasting periods of risk compression,” they said.

It was zinc’s turn to shine in the commodities market, as prices surged above $3,000 a metric ton Wednesday for the first time in almost a decade in a broad rally for metals. Aluminum approached a three-year high, adding momentum to a rally fueled by bets on tightening supplies and robust demand. Nickel, copper and lead also advanced as shares of miners jumped, with Freeport-McMoRan Inc. among the biggest gainers. An index of base metals climbed to a two-year high last week amid better-than-expected demand in China and a weakening dollar, according to Bloomberg News’s Mark Burton and Winnie Zhu. The Asian nation is stepping up efforts to shut illegal aluminum and steel plants to cut emissions and excess capacity. A push to promote economic growth in China ahead of a leadership reshuffle later this year is also lifting industrial-metals use, said Bernard Dahdah, an analyst at Natixis in London. “Earlier this year, a lot of the rally was supply related, but recently we’ve seen demand starting to support as well,” Dahdah said.


Just because Thursday’s report on euro-area inflation for July is the second and final estimate doesn’t mean there won’t be useful information. While the original estimate is rarely revised -- and the median estimate of economists surveyed by Bloomberg News shows that will likely be the case again as they still see an increase of 1.3 percent from a year earlier -- the strategists at RBC Capital Markets said there is an outside chance of a downward revision. They pointed out in a research note that July marks the beginning of the European summer holidays, which may have pushed up prices in certain categories, including airfares. The greater detail that comes with the final release will indicate whether that is the case or whether this is the beginning of an upturn in underlying inflation, they note. Their take is that it’s still too early to make that call and it’s still more likely that the recent upturn in core inflation is being driven by seasonal factors.

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