Monday, November 14, 2016

November-December 2016 Outlook: Trumping All Expectations

November-December 2016 Outlook: Trumping All Expectations
Mon, 14 Nov 2016 13:22 PM EST

After the shocking Brexit vote result this summer markets were a little better hedged for the surprise Trump victory, but it was still astonishing to see the pollsters get it so wrong again. Instead of four more years of the same government gridlock in Washington, the prospect of a united US government initially raised hopes that a pro-business agenda could emerge. For the time being, markets have ignored the "temperament" issue and the question of whether a President Trump will remain a maverick or go along with the Republican Congress that shunned him during the entire campaign.

In the immediate aftermath of the surprise Trump victory, interest rates rose and stocks moved back toward record highs on optimism that the US will have functional government that that President Trump will keep an an even keel. In the days since the election, Mr. Trump has been more subdued than he was on the campaign trail and has so far kept his famous outbursts in check. Between now and his inauguration in January, every move he makes will be closely scrutinized, and other major world events will have to be viewed through a prism of how the new Administration might react to it. Uncertainty will persist for months to come until the Trump White House starts to fall into a clear pattern. Until then it won't be clear as to whether Trump will flout the Washington establishment (after all, Trump's mandate was to dismantle the old order in Washington and he ran against the establishment of BOTH parties) or if he will quickly fall in line with Republican orthodoxy in order to get a pro-growth, anti-regulation agenda passed quickly.

Early indications will come from Trump's choices to fill top posts. The first big tell may be the selection for Chief of Staff which is coming down to Republican National Committee Chairman Reince Priebus or Steve Bannon, the Trump campaign CEO and executive chairman of the "alt-right" Breitbart News. Choosing Priebus to be his closest White House advisor would give Republicans some assurance that the new President wants to work with them, while naming Bannon to the position would be another shot across the bow of the establishment [Update: press reports now say Priebus will be chief of staff, but Bannon will be kept on call as "chief strategist"] . Another question is whether Trump will push his own legislative agenda or if he will allow Congress to set the tone. If Trump is content with just being a figurehead for the "Make American Great Again" movement, the Congress may run roughshod over the White House.

Trump has stated his early focus will be on three top priorities: health care, border control, and jobs. Congress seems likely to support a long-overdue spending on infrastructure and jobs growth, and Republicans will help pass legislation on immigration, healthcare, and tax reform, including a tax holiday for repatriation of corporate earnings from overseas. Republicans will also welcome the Trump Administration rolling back numerous executive orders that President Obama used to implement environmental regulations and other policies that could not be squeezed through the obstructionist Congress.

Trump may come into conflict with the GOP establishment when it comes to trade policy, where the Administration has a lot of authority that is independent of Congress. His election mandate was largely built on vague promises to renegotiate trade deals including NAFTA which could put the new Administration in direct conflict with a Republican Party establishment that overwhelmingly supports free trade. The President-elect's pledge to name China a currency manipulator "on day one" could also draw focus away from the domestic agenda. In response to the Trump victory, China's vice finance minister Shi calculating stated that it remains to be seen if Trump will implement his campaign rhetoric and that the president-elect should be aware of the benefits of economic cooperation with China. If Trump delivers on his protectionist rhetoric, markets could shudder at the prospect of a trade war damaging the global economy. He could also make waves for individual companies that move production jobs overseas by imposing tariffs on goods that they produce outside of the US. Fiscal conservatives may also cringe at efforts by the Trump Administration to finance big spending projects.

Populism Trumps Polls

The early days of the Trump Administration will coincide with the next phase of the UK's Brexit drama. The Bank of England has just diminished uncertainty about its policy future, but that was offset by new uncertainties about the Brexit process. Shortly before the November policy meeting, BOE Governor Carney turned aside speculation that he might resign early and instead announced that he would stay on through 2019 to guide the central bank through the entire Brexit process. Then at the meeting, the policy committee essentially stated that it had taken the prospect of another rate hike off the table.

The same day, the mechanics of the Brexit were thrown into question as a UK court ruled that the Parliament should have a say in the government's plans for disentangling itself from the EU, raising the prospects for a "soft Brexit" which would retain certain agreements with the EU including adherence to free movement of people rules. Specifically the court said the government must get Parliamentary approval to invoke Article 50 which triggers the two-year process of leaving the EU.

Members of the May government have increasingly hinted that they'll push for a "hard Brexit" that would allow the UK to control immigration from the European Union, even if that means giving up membership of the European common market. The government is in the process of appealing ruling on Parliamentary oversight to the nation's highest judicial body and a decision is anticipated before the year end. If that timeframe stays true, the government has said it will remain on track to invoke Article 50 by the end of March.

Some political observers are concerned that starting the Brexit process in March will play into the hands of populists across Europe, whose fortunes appear to be on the rise after the votes on Brexit and the US Presidency. France and Germany will hold national elections in 2017 - France in the spring and Germany probably in late September. In France, Marine Le Pen and her National Front (FN) are running competitively with the candidates of the two traditional leading parties, positioning the anti-immigrant populist to be one of the two choices in the run- off election for President in May. Meanwhile in Germany, the right wing populist and euroskeptic Alternative for Germany (AfD) is poised to gain seats in Bundestag for the first time after running strong in several state elections this year.

OPEC Self-Interest Trumps Cooperation

Outside of rise of populist politics, probably the biggest uncertainty in the weeks ahead is the fate of the "oil freeze" deal that was tentatively agreed upon in Algiers a month ago. That preliminary agreement helped oil prices get back above $50/bbl for a time, but the price has eroded again as OPEC members continue to bicker over who should participate in a freeze or cut, and as non-OPEC producers have also wavered. With just a few weeks to go before the November 30th semi-annual OPEC meeting that was to usher in the finalized production deal, market watchers are starting to lay odds against a final accord being enacted.

As the case has been since the oil freeze idea was conceived, the main tension has been between Saudi Arabia's block of Gulf producers and Iran, which wants to recoup all of the market share it lost due to anti-nuclear sanctions. Technical level meetings over the last few weeks have not achieved a breakthrough, though more meetings are scheduled. It's clear the frustration level is high, exemplified by a press leak that suggested the Gulf nations threatened to INCREASE production if Iran didn't get on board with plan (that threat was later walked back to a suggestion that the Gulf producers would shift capacity to "meet market demand"). For its part, Iran's oil minister just recently commented that it does not see November 30th as a hard deadline for reaching an accord, calling into doubt whether producers can come to an agreement at all this year.

Given these circumstances, there is a good chance the freeze deal will not come to pass, or at least get delayed. In that case WTI crude could easily sink back to the low $30s, dragging down the energy sector with it and taking some more air out of equities. It could also give headaches to central banks that had been elated to see the downward inflation pressure exerted by low oil prices finally abating over the spring and summer.

Fed Tightening Finally Trumps Accommodation

The US Fed is hoping that inflation will continue to rise enough to justify another rate hike. The December 14 FOMC meeting will be a crucial moment for Fed credibility. When the Fed raised rates last December the dot plot projections suggested there could be FOUR rate hikes during the course of 2016. Since then, the Fed has found excuses to keep rates on hold, ranging from stagnant growth in Q1, to the Brexit uncertainty over the summer. By intimating for the last year that the next rate hike is coming soon, the Fed has lost a lot of the benefits of keeping rate policy unchanged for the last 10 months, and it would be a major blow to the Fed's reputation if it holds off on a rate hike yet again in December.

Additionally, the voting membership will change after the December meeting - in 2017 all three of the recent hawkish dissenters will rotate out and will be replaced by a decidedly more moderate group of Fed presidents. Chair Yellen has already indicated a willingness to let the economy "run hot," so as long as there is no sign of runaway inflation, the Fed may be even more reluctant to raise rates next year.

The November statement edged the Fed closer to a December rate hike, announcing that the case for a hike "continued" to strengthen. But until the FOMC actually pulls the trigger on another 25 basis point move, markets are right to be skeptical of hawkish signals. Though some Fed watchers may be worried that the 'era of cheap money' is over, the promise of a "gradual pace" of rate hikes may well mean that the market opinion starts coalescing around the one-and-done rate hike view of St Louis Fed President Bullard. So far, markets have been unperturbed by the prospect of a December rate hike, and may even take it as positive development if the Fed framed the hike as a vote of confidence in the economy.

The Trump Administration will also exert some influence on the Fed. Trump has been broadly critical of the Fed and said earlier this year that he wants to replace Chair Yellen because she is political and "not a Republican," though he also declared that both she and he are "low rates" people. Unless the Chair chooses to tender her resignation and triggers an earlier succession, the new President will have the option to name a replacement at the end of Yellen's term in early 2018. In the meantime, two vacancies on the seven-member board of governors will allow Trump to put his imprint on the Fed immediately.

The Republican controlled Congress may also try to persuade Trump to support legislation to reform the central bank. Last year the House passed a bill that would require the Fed to set a policy rule, and the 2016 GOP party platform called for an annual audit of interest rate decisions. The central bank has argued that the 'audit the Fed' legislation would put undue political pressure on monetary policy decisions, but that may just be the new reality in the era of America's first modern populist president.

1: UK Manufacturing PMI; US ISM Manufacturing PMI
2: UK Construction PMI; FOMC policy statement; China Caixin Services PMI
3: UK Services PMI; BOE policy statement; US ISM Manufacturing; US Factory Orders
4: US Payrolls & Unemployment

7: German Factory Orders; China Trade Balance (tentative)
8: Japan Current Account; China CPI & PPI; US ELECTION DAY
9: UK Manufacturing Production; US JOLTS Jobs Openings
11: US Prelim University of Michigan Sentiment

13: China Industrial Production; Japan Prelim Q3 GDP
15: UK CPI & PPI; Euro Zone Prelim Q3 GDP; German ZEW Economic Sentiment; US Retail Sales
16: UK Claimant Count & Unemployment; US PPI; US Industrial Production & Capacity Utilization
17: UK Retail Sales; Euro Zone Final CPI; ECB Minutes; US Housing Starts & Building Permits; US CPI; Philadelphia Fed Manufacturing Index

21: Various Euro Zone Manufacturing & Services PMIs
22: US Existing Home Sales
23: US Durable Goods Orders; US New Home Sales; FOMC Minutes
24: German Ifo Business Climate; Tokyo Core CPI; US THANKSGIVING HOLIDAY
25: UK Q3 GDP Second Estimate

28: Japan Household Spending
29: German Unemployment; BOE Financial Stability Report; US Prelim Q3 GDP; US Consumer Confidence
30: OPEC Semi-Annual Meeting; German Retail Sales; Euro Zone Prelim CPI Estimate; US Personal Income & Spending; Chicago PMI; China Manufacturing & Non-Manufacturing PMIs; China Caixin Manufacturing PMI
1: UK Bank Stress Test Results; UK Manufacturing PMI; US ISM Manufacturing PMI
2: UK Construction PMI; US Payrolls & Unemployment

4: Italy Referendum on Constitutional Reform; China Caixin Services PMI
5: UK Services PMI; US ISM Non-Manufacturing
6: German Factory Orders; US Trade Balance; US Factory Orders
7: UK Manufacturing Production; Japan Final Q3 GDP; China Trade Balance (tentative)
8: ECB Policy Statement & Press Conf; US JOLT Job Openings; China CPI & PPI
9: Prelim University of Michigan Sentiment

12: China Industrial Production
13: UK CPI & PPI; German ZEW Economic Sentiment; Japan Tankan Manufacturing & Non-Manufacturing Indices
14: UK Claimant Count & Unemployment; US Retail Sales; US PPI; US Industrial Production & Capacity Utilization; FOMC Policy Statement & Updated Economic Projections; FOMC press conference
15: UK Retail Sales; BOE Policy Statement; US CPI; Philadelphia Fed Manufacturing Index
16: Euro Zone Final CPI; US Housing Starts & Building Permits

18: BOJ Policy Statement (tentative)
19: German Ifo Business Climate
21: Various Euro Zone Prelim Manufacturing & Services PMIs; US Existing Home Sales
22: US Final Q3 GDP; US Personal Spending
23: US Durable Goods Orders; US New Home Sales

26: Japan Household Spending; Tokyo Core CPI
27: UK Current Account; UK Final Q3 GDP; US Consumer Confidence
30: Chicago PMI
31: China Manufacturing & Non-Manufacturing PMIs