E Markets: Politics As Usual

Back room deals with cigar smoke and the smell of money meeting greed. The mood for markets and how they deal with politics as a key driver doesn’t get easier. The uncertainty of US trade policy balances against stronger US economic data all coated with ugly US politics.

The last week brought a general de-risking after a long summer of relative calm. The arguments that emerging market pain won’t affect developed markets began to fray and the divergence of US outperformance holding for another six months also was cast into doubt. Buying the dip last week didn’t work and it will be key to watch to see if it fails again next week.

Both bonds and stocks lost value last week highlighting the pain of positioning. On one hand, US trade policy towards China with the threat of ever more tariffs seems to be leading to a dramatic slowdown of growth there and in emerging markets in general. On the other hand, US politics are seen tempering Trump with the mid-term elections expected to swing to the democrats and a Congress untied in opposition to his policies. Leaders in Beijing bank on this point while Washington seems convinced of the China pain leading to better terms. The reality is that both may not happen as expected and risk markets are two binary for the grey world in which we live.

Politics as usual are raising dark clouds over markets that have been comfortable with central bankers leaving easy money inflating assets if not the real economy. The hope for a dovish turn of the FOMC as inflation seems contained lost ground with 2.9% y/y wage growth and the US CPI/PPI data in the week ahead maybe more important accordingly.  

The turn into next week will be in the clash of how the ECB and BOE describe their reaction function to emerging market pain and the US/ China trade war risks along with their own domestic issues. Most rational players want normalization to happen but not if it kills the recovery there. The complication in the US and abroad is in the role of politics adding to doubts about central bank independence and how populist politics threaten the credibility of all institutions globally. There is nothing usual in this shift and the surprises are still likely to come from politics rather than economics making traders a lot less comfortable and volatility is something to expect in the weeks ahead. The biggest risk for next week is in the headlines we don’t expect – as we learned from the Japan typhoon and earthquake or the NY Times Trump senior aide editorial.

The focus next week will be on Europe given the ECB and BOE meetings and the list of things that matter to analysts is well understood. Fear will come out of anything not expected.

What Happened over the Weekend? 

Focus is on the Swedish Election, China Trade reports and the Trump Trade policy. But other politics remain in the headlines from Germany to Australia.

1) China August trade surplus $27.9bn from $28.05bn – less than $39.9bn expected. Exports were up 9.8% y/y after 12.2% - a bit less than the 10% expected – while imports rose 20% y/y after 27.3% - more than the 18.7% y/y expected.

2) Sweden polls are all over the place. Market is not certain of this outcome but fear a rise in anti-immigrant policy and swing to right.

3) Australia by-election in NSW swings against Liberal coalition.The rural voters in Wagga Wagga voted out the party for the first time since 1956. The new PM Morrison faces parliament push back Monday over the Liberal Party treatment of woman.

4) North Korea 70th anniversary military parade doesn’t showcase ICBMs. There were no nuclear tests and editorials pushed for unification with South Korea. This is a shift for Kim Jong-Un who has been pushing economic development over his nuclear ambitions in the previous parades.

5) Merkel’s grand coalition hits new low in polls. A poll from Emnid for Bild weekly shows the CDU and CSU off 1% to 29% - that is off from 32.9% from the election win last year. SPD was off 2% to 17% on the week and from 20.5% during the Sep 2017 election. The joint coalition is 46%, the lowest for any of the grand coalition under Merkel from 2005-2009 or 2013-2017.

Question for the Week AheadAre markets too calm for the policy and political risks ahead?

Since 2009 we have been trained to buy the dip, ignore the fear of contagion and to soldier forward with the promise that central bankers will always provide financial stability. Whether you look at bonds, stocks or even G10 FX, the lack of any sharp uptick in volatility suggests little fear about contagion in 2018 – whether that is about emerging markets or FOMC policy mistakes or about Trump trade uncertainty. The US data last week should be viewed as potentially changing this calm given that the doves on the Fed look vulnerable to rising inflation reports – with the CPI/PPI in the week ahead critical to their arguments to remain credible.

The other point about volatility is the underlying trend in US shares has been muting anything from politics. Stocks can ignore politics if the FOMC is seen as only “normalizing” rates rather than tightening them. Stocks can also ignore politics as long as the economy remains robust along with corporate profits and margins. The trend is your friend with the Fed and Trump allowing investors buy-the-dip opportunities. This, too, maybe doubted with politics heating up into the US mid-terms and the correlation of Trump/Republican polls and more aggressive policy pushes on trade higher. This fear of a more erratic Trump ties into the Thursday NY Times editorial and the upcoming Bob Woodward book on the President. Polls drive politicians to act.

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