In a shocker that certainly rivals Brexit, Donald Trump has overcome what should have been an insurmountable deficit in the opinion polls to become the 45th President of the United States. This Trump victory serves up far more questions than answers and that is one of the reasons why markets have reacted with a flight from risk and into safe haven asset plays. Trump may have come across as conciliatory in his acceptance speech (realistically can anything else have been expected?) and this could set the tone for the coming weeks. In my early thoughts of this shocking result, there are 4 issues that Trump’s victory serves up.
The opinion polls got it spectacularly wrong…again!
After Brexit, it should have been once bitten twice shy, but the markets were positioned once more squarely behind the continuity candidate. Volatility has been sizeable, although the initial reactions have been retraced to an extent. However pundits and political analysts seems to have got it wrong again, and the markets went along with it. In the coming days and maybe weeks and months there will need to be some significant shifts in asset allocation.
The political mood of an election campaign has once again been misjudged – Europe be worried!
The anti-establishment, populist, nationalist vote is burgeoning. First, as we saw with Brexit in the UK and now the victory for Donald Trump in the US. The tide certainly seems to be turning against the political elite. Voters have become fed up with the lack of economic progress since the 2008 financial crisis and now these views are being reflected in the elections.
What does this mean for the key elections in Europe in the coming year? Immediately in December, Italy holds a referendum which is effectively a vote of confidence in Matteo Renzi, there is a general election in the Netherlands (in March), the presidential election in France (in May) and German federal elections (possibly September). All of these could throw up big changes, with the prospect of a National Front president (Marine Le Pen) a real possibility. The UK and US have ploughed the road for further seismic shifts in global political stance.
Treasury yields are steepening – December questioned, inflation down the road?
Trump’s acceptance speech contained several mentions of creating jobs and infrastructural spending. Spend, spend, spend, oh and lower taxes too. That means a higher deficit. Keynesian style spending tends to be inflationary and the US 10 year Treasury yield is 3 basis points higher. The bond markets are suggesting that Trump will generate inflation as the longer end of the yield curve pushes out.
However, the shorter end of the yield curve is a different story. Donald Trump has also been extremely critical of the Fed, whilst with the uncertainty of the implications of a Trump presidency are as yet unknown. There is now a significant question mark over a December rate hike by the Fed. This is a drag on shorter term rates. It would still be very difficult for the Fed to justify holding off from a rate hike in December having been all but nailed on just last week. However, interest rate futures have dropped back and are now not far off 50/50 again, according to Bloomberg. The 2 year Treasury yield has dropped by almost 5 basis points.
Will the weaker dollar last?
The initial market moves have been nowhere near the doomsday scenarios suggested in the speculation of a Trump victory prior to the election. After an initial spike of weakness as the swing states stated to go to Trump early this morning, the dollar has retraced some of its losses. Interestingly, the regained ground came in the wake of his acceptance speech which spiked Treasury yields back higher.
EUR/USD is around $1.1100 which has long been a key pivot area and Dollar/Yen is back into a support band 102.55/103.15. Furthermore, gold is trading in a pivot band $1300/$1310 again. These will be seen as key barometer levels for the outlook of risk and the dollar.
The Fed might be tempted to hold off from hikes and blame market turmoil, however rising Treasury yields that imply increasing inflation expectations will add hawkish pressure, whilst taking account of a weaker dollar also gives the Fed room to hike. It could be that dollar weakness may only be short-term. The chart below shows the uptrend channel on the Trade Weighted Dollar remains intact.