Donald Trump’s election victory has a major effect on US and global financial markets over the last couple of months.Bonds are out of favour, stocks are in as Trump looks to
- lower personal and corporate taxes
- significantly increase infrastructure spending
- decrease regulatory pressure on corporations especially banks
Optimism for U.S. growth and corporate profits is sky-high and US equities are trading at all-time highs accordingly. Stronger US economic growth, and associated inflation, has led the financial markets to price in 3 quarter point interest rate increases in 2017. The prospect of higher US interest rates has taken the US Dollar to a 14 year high.Inflation is generally on the up in the developed world, not just the US, taking global bond yields sharply higher and off multi-decade lows.
Here are six major topics to know for a January interview.
Inflation on the up
The rising outlook for inflation is a big theme for 2017 and it was underscored on Tuesday after German consumer prices staged a sharp 1.7 per cent rise from a year ago, beating expectations of a 1.3 per cent advance. Though underlying price pressures remain weak, the data may embolden European Central Bank hawks to shift away from loose monetary policies.
Headline inflation data in the euro-area and the U.S. in the coming months may be fueled by a pick-up in energy prices. Oil rose to almost $58 a barrel for the first time since July 2015, amid output cuts in Kuwait and Oman that suggest OPEC and its partners are going to deliver on an agreement forged last year to scale back production.
Dollar in favour
Markets are also grappling with the prospects for the US Dollar after its Trump-fueled climb.The ‘greenback’ has notched a 6.5 per cent gain since the Nov. 8 election, as expectations of looser regulations, higher government spending, and lower taxes bolster the outlook for U.S. growth and inflation.
The dollar rally raises the question: Will the strength of the greenback pose a headwind for US export output in the second half of the year? Given many emerging countries borrow in US Dollars, servicing US Dollar debt will require an increasing amount of local currency and could become problematic.
China is one emerging market country that is reeling from the effects of a stronger dollar, which is serving to fuel capital outflows and tighten onshore domestic liquidity. To this end, China dropped a year-end surprise on sleepy currency markets, when it downgraded the relative importance of the dollar in its trade-weighted foreign-exchange basket, in an effort to better reflect the yuan’s valuation against its trading partners. Though the move may have eased the risk of a one-off devaluation, yuan-depreciation expectations have surged year-on-year.
An uptick in the global industrial production cycle may give Chinese policy makers some breathing space. On Tuesday, we learned UK manufacturing data for December advanced at its fastest pace in 30 months, helped by resilient demand and a weaker pound. In addition, Institute for Supply Management data showed that last month American manufacturing grew at its fastest pace in two years, underscoring soaring business confidence.
Euro-area manufacturing also grew in December, at its fastest pace since April 2011, feeding the market narrative that inflationary pressures are building up in the developed world, and that Corporate Europe is on a stronger footing.
Shifting bond yield curves
Another major theme this year is the outlook for term premiums;the extra compensation investors demand to hold longer-dated government bonds relative to shorter-dated obligations. In the U.S., U.K., and euro-area, they fell sharply in the middle of last year as markets bet that central banks would keep monetary policies loose. This sentiment is changing rapidly. Long maturity (circa 30 year) US bond yields have risen over 100 basis points (1%) in the last six months with most of that rise in the last quarter.
Financial markets threw caution to the wind last month, pricing in buoyant growth even as the specter of global trade wars looms large. Just two-and-a-half weeks before his inauguration, Trump tweeted another protectionist sideswipe at Beijing.
“China has been taking out massive amounts of money & wealth from the U.S. in totally one-sided trade, but won’t help with North Korea. Nice!”
How long the Trump ‘grace period’ lasts will be a significant factor for US and global markets in the first half of 2017.
S&P 500: 2260
FTSE 100: 7135
Bonds – 10 Year Government Yields
EUR/USD 1.0600 (1 euro buys 1.0600 dollars)
GBP/USD 1.2500 (1 pound buys 1.2500 dollars)
OIL: Brent: 57.00 (dollars per barrel)
GOLD: 1180 (dollars per ounce)
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