Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 23 February 2017 at 13:45 GMT

A rock and a hard place

Head of Trading / The ECU Group plc
United Kingdom

  • The latest Federal Open Markets Committee minutes provide little new information
  • Accordingly, the market response to them was muted
  • Meanwhile, all eyes are on Trump's State of the Union address next Tuesday
  • If he delivers a clear plan, post-election rallies will likely see a comeback
  • But if he gets it wrong, the consequences could be disastrous


Nasa has discovered seven potentially habitable planets orbiting a nearby star. Of course, "nearby" is a relative term. Photo: NASA/JPL-Caltech 

By Neil Staines

“Only two things are infinite, the universe and human stupidity,” — 
Albert Einstein

The announcement last night that Nasa astronomers have spotted seven Earth-size planets around a nearby star is an amazing development, and one which invites huge scientific and philosophical debate. The position in the ‘habitable’ or ‘Goldilocks’ orbit zone means there is a greatly increased likelihood of life. It is therefore not inconceivable that on one of those planets (currently named b - h) an alien leader, perhaps with a slightly orange hue, is promising to make planet b ‘great again’.

The rather flippant use of the term ‘nearby’ to describe this solar system that is around 39 light years (a mere 235 trillion miles) away is vaguely analogous to the other important announcement last night as Federal Open Market Committee members declare a US rate hike “fairly” near.  Timing, as they say, is everything.

In reality, the minutes from the February 1 policy meet provided little new information. The central projection of three rate hikes in 2017 from the Fed do not leave a great deal of flexibility. However, from our perspective, the minutes highlight a macroeconomic backdrop where inflation is moving in the right direction; but at such a slow pace that it warrants much repetition of the word ‘gradual’ in the Fed lexicon. But little action, yet.

The response of the interest rate markets was to lower the implied probability of a March rate rise (albeit slightly) and edge up the probability for May. The majority of the board continue to see only a modest risk of “significant inflation”, and while the Fed pointed out the downside risks from further dollar strength, they were also open to upside risks including fiscal stimulus.

“Your theory is crazy, but it’s not crazy enough to be true,”  Niels Bohr

Herein lies the issue. Since the election of Donald Trump, there has been a substantial rally in equities and risk assets, yields, inflation expectations, and the dollar, essentially premised on the expectation of substantial fiscal stimulus. The market response to the Fed minutes on Wednesday night was very muted. Indeed, the market response to almost all economic data and monetary indicators of late has been very muted. The core drivers of financial markets are politics and fiscal policies.

In the US, the expectations are becoming concentrated on the presidential speech to Congress next Tuesday – the State of the Union address. We now feel that there is genuine two-way risk.

If Trump delivers a clear plan with near term implementation, then it is likely that all the enthusiasm of the end of 2016 returns with continued gains in US yields, equities and the dollar.

A Trump dump?

Disappointment, either in terms of content or timing, however, could induce a significant correction across the financial market spectrum. Positioning remains at extreme levels in US Treasuries and oil markets, where a misstep from Trump could see sharp falls in yields and oil prices, but it is unlikely to stop there.

The Chinese economy is likely at a fragile juncture, where declines in global confidence and corrections in equity and asset markets could be very detrimental to the current (transient, in our view) stability. On the flip side, an accelerated pace of Fed tightening as a function of a convincing and significant fiscal stimulus would likely be equally troubling.

Essentially, we feel that we are entering a period of acute sensitivity for the global economy, the progression of which is dependent on fiscal policy and politics (in Europe as well as the US) 

Adding to the complexity of the fiscal issue, Trump tweeted last night that the US budget is “absolutely out of control” – not the ideal starting point from which to launch a significant fiscal easing. Next Tuesday is likely to be a very significant day for financial markets, and for president Trump. If he gets it wrong there will be nowhere to hide in the financial markets – at least not within 39 light years.


 An artist's impression of the surface of newly discovered TRAPPIST-1f – could this be your only refuge from a misstep by president Trump? Photo: NASA/JPL-Caltech

– Edited by Jack Davies

Neil Staines is head of trading at The ECU Group


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