Everybody has opinions on the recent election outcome but as usual most of the opinions are from the echo chamber and not factual in any way. This blog is dedicated to seeking profitable investment and trading opportunities as I sort through the noise of the financial media. As with Brexit, the punditry found itself trapped in its own rhetoric and every prediction but the weakness of the pound proved to be WRONG, at least in the short to medium-term. British Gilts (10-year notes) rallied substantially in the post-Brexit confusion and most importantly the Footise stock index rallied 15% off its election night bottom. The POUND did weaken substantially against the U.S. dollar and the euro currency but I have argued for a few years that the British current account made the relative strength of the POUND to its key trading partners unsustainable.
The POUND has recently stabilized as the EUR/GBP trade has been unwound and the U.S. dollar has rallied 6 percent against the EURO and YEN since the night of Trump’s election. For you traders the 0.8317 area of the EUR/GBP cross should provide support as it was the high made June 24 after the Brexit vote. The best thing the Brits have going for it is the depreciation of the pound as they strive to sustain British economic growth in the face of diminished foreign direct investment.
Of course we are all cognizant of the failure of the experts to predict the Trump electoral victory let alone how badly their investment recommendations performed. Many analysts and hedge fund gurus predicted a fall in bond yields, a decline in equity prices and the U.S. dollar and, of course, a dramatic rise in gold and silver prices. Two weeks after the market paroxysms of November 8-9, bond yields are significantly higher as futures on the 10- and 30-year Treasuries have fallen precipitously, the dollar has rallied against most world currencies, GOLD and silver have lost 10-15 percent of their election night rally. Most significantly, the SPOOS and Russell equity indexes have made ALL-TIME HIGHS.
In a bow to consensus, fed fund futures are indicating a mere 100 PERCENT CHANCE of a rate hike at the December meeting, so a HIKE OUGHT not disturb the present market configuration too much. The dollar has certainly been a headwind for some FOMC voters (Lael Brainard) but if the consensus is correct she would be a lone dissenter. Stanley Fischer was out exercising his vocal chords today. He noted that ultra-low interest rates were resulting in the overvaluation of certain assets, like corporate and sovereign bonds within the global financial portfolios. This is not new of course, as Harvard Professor Jeremy Stein warned of this outcome prior to his resignation in May 2014. The FOMC is admitting to some of the criticisms that have been leveled at them over the previous years but is the acknowledgement coming too late?
Rick Santelli has been noting the mispricing of assets because of FED policy for the last five years (as have I), but with the strength of the dollar and the political uncertainties in Europe and elsewhere, will the FED create instability if they guide rates even higher for 2017? If the Fed signals a one and done, then will it be full speed ahead for global equities? If rates continue higher than the equity market rally cannot continue much longer because the huge amount of debt on corporate balance sheets will be financed at ever-increasing interest rates. In 1981 when Ronald Reagan entered the White House, the U.S. had a $3.2 Trillion GDP and total debt (public+private) of roughly $5.3 trillion. Today, the U.S. has a $17 Trillion GDP and a total debt load of $62.5 trillion (source:FRED).
The rising yields on BONDS, public and private, stand to be a drag on equity markets as the Trump rally begins to be assessed in terms of fundamentals. Yes, if Yellen holds rates steady and allows inflation to run hotter for longer then equity markets will have to recalibrate as the debt load will be diminished through the magic of inflation. Remember that the Rogoff stance is overleveraged economies can either restructure the loans or utilize inflation to reduce the pain of a debt overhang. But, if inflation runs hotter, then the dollar rally will be questioned as will the break in the precious metals. If central banks are seen to fail in combating any upward price pressures then GOLD versus fiat currencies will become my investment of choice. Let the celebration of potential Trump positive outcomes continue but I will be vigilant as to how the FOMC is reacting:
For What It Is Worth