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New Calculus

Markets face a fresh puzzle after U.S. President Joe Biden's sudden announcement on Sunday that he's dropping out of the race against former President Donald Trump. It's as if the political game of chess has flipped its board, and investors are left picking up the pieces. This unexpected twist has injected a hefty dose of political uncertainty into the market, leaving everyone scrambling to determine their next move.

As if that wasn’t enough, Friday’s global cyber disruption added a tech-induced headache, causing the S&P 500 and Nasdaq to suffer their worst weeks since April.

Please don’t lose the plot. This week's mega tech earnings are still the focus, and investors are already biting their nails. The cyber hiccup was like spilling coffee on an already jittery hand. Before this, the "Trump trade" was more like an elusive unicorn—often talked about but never quite seen in the wild.

The prevailing assumption was that Trump's trade wars and tax cuts would be inflationary, walloping the bond markets and potentially triggering severe debt risks. But now, with Biden bowing out, investors are racing to decode this new uncertainty.

Despite the doom-and-gloom predictions that Biden’s withdrawal will lead to significant risk aversion, I beg to differ. Traders might not run for the hills but could tweak their odds of a Republican sweep. Depending on the polls, the Trump trade could gather new steam or move in reverse, making the market feel like the financial world’s version of teeter-totter. In other words, it is subtle, not cunning. The economy still ultimately drives the bus.

U.S. President Biden has thrown his support behind Vice President Kamala Harris to lead the Democratic ticket, but the party's final pick remains up in the air. Over on the political betting website PredictIt, contracts for Harris as the Democratic candidate are priced at 83 cents, suggesting she's the frontrunner but not a guaranteed lock. Meanwhile, contracts for a Trump victory over Harris are trading at 61 cents, with a potential $1 payout. In other words, there is only a - -4 cent change in the overall White House race while the odds of Harris rose as the Biden endorsement separates her from the crowd.

Since the political theatrics involving Donald Trump, the dollar has been flexing its muscles, reflecting a round of pre-emptive positioning as the odds of Trump’s re-election seemingly rise. But if those odds start to fade, we could see the dollar soften around the edges. Despite this, the broader macroeconomic story will likely be the primary driver of foreign exchange in the near term.

With inflation cooling and indicators like the Citi Economic Surprise Index practically screaming for a rate cut, we might see a more decisive pivot from the Fed at the upcoming FOMC meeting. Christopher Waller, one of our favorite Fed voices, provided a particularly enlightening update last week. His speech, aptly titled "Getting Closer," confirmed that the recent softening in U.S. price data has the Federal Reserve inching back toward rate cuts.

The only reason the market hasn't hammered the dollar yet is that it's still trying to figure out the so-called Trump trade and the possibility that the Fed might remain cautious on what could still be a bumpy economic road ahead. It's a bit like trying to drive with a foggy windshield—you know you need to move forward, but you’re just not sure what's lurking around the next corner.

The Asian financial market will be the first to react, but it is coming off a rough week for global stocks, marked by MSCI's global index having its worst week since April. The primary culprit? Concerns about trade disruptions, particularly Washington's latest restrictions on semiconductor sales to China. Unsurprisingly, traders were trying to navigate a minefield last week; they took a few hits.
 

There Is No Fiscal Crisis In The US Under Anyone

The chatter around a potential U.S. fiscal crisis under Trump has been as lively as a Wall Street cocktail party. Some are even predicting a "Liz Truss Moment" for the U.S. economy, arguing that the fiscal deficit is ballooning and public debt levels are reaching dangerous heights, setting the stage for eventual fiscal ruin. Indeed, Trump will inherit quite a mountain of debt and a hefty interest coupon to match. So yeah, unless the economy skyrockets or his tariff gambit pays off in spades to fund the tax cuts, I honestly can’t see Republican fiscal hawks agreeing to looser fiscal beyond the 1-year presidential honeymoon phase.

The U.S. public sector debt-to-GDP ratio has skyrocketed to 120% from a modest 35% in 1980, which would make even the most seasoned investor's head spin. Yet, long bond yields, both nominal and real, have dramatically fallen during the same period. It's a paradox that has puzzled many. For context, look at Japan: its debt-to-GDP ratio stands at a staggering 220%, but its 10-year yields barely scrape 1%.

One thing we can all agree on: the correlation between debt levels and interest rates is, in fact, negative. If a country doesn't borrow in foreign currency, the dreaded "fiscal risk premium" doesn't exist because the central bank acts as the "buyer of last resort." Period. You might face a currency crisis, an inflation problem, or even both, but a sovereign debt problem? Not so much. It's like having a safety net that catches you just before you hit the ground, albeit with a bit of a bounce.( Alpine Macro)

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