After the strong performance in almost every equity market in 2017, characterised by a remarkable lack of volatility, the financial weather changed abruptly in the middle of the last quarter. The trigger was a stronger than expected jump in US hourly wages in January. This inflationary fright rattled markets and led to a steep sell off in bonds and equities. As the quarter progressed a less alarming picture of inflation emerged. However markets had become extended and they have not settled down, while further anxiety was caused by President Trump threatening trade tariffs which could upset the global trade system that has been in place for the last thirty years, and a scandal involving Facebook, one of the market leaders.
Markets took Trump’s election victory calmly with the S&P 500 recording gains in every month of 2017. One of the positive features of his Administration has been the reduction of regulations. For example the number of pages of the Federal Register has risen steadily since World War II. In the past year they have dropped from almost 100,000 pages to 54,153, partly due to the Trump program requiring two regulations to be cut for every one added. They cut more on top of that. This is a dramatic change that gives American business considerably more operating flexibility. The tax cut he pushed through in December led to a spike in the stock market in December and January, but the inflation number and some geopolitical rumbles caused the market to be more sceptical of Trump. On the economic side the concern for the bond market is the substantial supply of bonds that will be needed to finance the recent tax cuts. The US budget deficit is forecast to expand from 3.5% to 6%, at a time when the Federal Reserve is withdrawing its policy of QE by reducing their purchases of bonds at a rate that will reach $50bn a month by October, so the bond market faces significant negative changes to both supply and demand. The tax stimulus is coming at a time of nearly full employment so the market is particularly sensitive to wage increases. On top of this the market must contend with the capricious nature of the President, whose policies frequently appear to be unanchored. It is never quite clear what his strategy is, and he has shown a far greater tendency to shift position on a policy than previous incumbents. One example of this is there has been an uncomfortably high turnover of White House staff during his tenure. This is unsettling for markets which prefer clear signals from global leaders on which they can base their decisions. President Trump also seems uninterested in the global bodies that have dominated the world over the past half century such as WTO, NATO and the UN. Whatever the merits of his view that these organisations constitute a bad deal for the US, the danger arises that if the US show less commitment to them then the world is left without a night watchman at a time when security fears are growing, creating further uncertainty. Another concern is the proposal of tariffs being imposed by the US. Anything that inhibits free trade is a negative, so the threat of protectionism weighed on the market at the end of the quarter. However the greatest threat may come from the changes that President Trump made to his senior team in March, which points to a far more hawkish approach on foreign policy, particularly towards countries that the US perceive as rogue states like North Korea and Iran. As a consequence geopolitical tensions have risen considerably this year. While any serious international rift effects markets, an action against Iran would directly affect the oil price and is therefore of more concern.
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