Sunday, May 7, 2017

May-June 2017 Outlook: 100 Days May-June 2017 Outlook: 100 Days
Sat, 06 May 2017 11:13 AM EST

In the 100 days since President Trump took the oath of office, the new Administration's efforts to recode the government genome and rewrite the diplomatic playbook have kept it at the center of geopolitical focus. Allies and adversaries alike are trying to get a read on the unpredictable new President even as Trump himself is starting to realize that the American political process cannot be changed so easily.

Though three months is not a lot of time on the political scale, the President's domestic agenda has not made much progress, bogged down by infighting in the Republican Party. Yet markets remain optimistic that at the very least tax reform will materialize. Simultaneously, Trump has thrown out the established foreign policy regime as he aggressively takes on trade issues and presses for greater military spending.

Outside of Washington, impending elections in France and the UK will help shape the future of Europe, and oil producers will decide whether tepid energy prices demand an extension of their output cutting deal. Meanwhile North Korea appears to be accelerating its weapons testing programs in light of increased pressure from the US and now China. Altogether, these political affairs will dictate the narrative of the next several months and to some extent will overshadow economic issues even as central banks are taking their monetary policy out of emergency mode after handling a decade of fallout from the financial crisis.

May Days

The first hurdle for the markets on the immediate horizon is the French election. The final round vote on Sunday, May 7, has been cast as a referendum on the future of a united Europe. The expected defeat of the nationalist candidate Marine LePen, who has pledged to withdraw France from the euro, will be an important moment for European solidarity.

LePen has consistently trailed Emmanuel Macron by 20 points in second round polling. That could lead to complacency on election day - less enthusiastic Macron voters might stay at home in the belief that the election is sewn up, which could make the final result much closer. Still it would take a huge turn of events - like a major scandal for Macron or a large scale terrorist attack - to swing enough voters toward LePen to create an upset.

Since the polls remain stable with just days until the election, a LePen win would be even more shocking than the Brexit or Trump victories (which were within statistical margins of error) and would likely throw markets into chaos. But if Macron wins as expected, it may blunt the momentum of the global populist wave that produced those upsets in the UK and US. In the short term at least, it should allay fears about the EU and euro zone coming apart and discourage nationalists that hoped to gain power in other European elections coming up this year. It should be noted however, that although Macron is pro-Europe, he is also an insurgent 'change' candidate, and his election would still be a rebuke of the two traditional parties in France who were shut out of the second round vote. It also remains to be seen if Macron can live up to the name of his party, En Marche ('on the move'), or if novice politician ends up supporting the status quo.

The expected French election result will remove an immediate existential threat to the euro zone, giving the EU a stronger hand in the Brexit negotiations. But the other near-term electoral event in Europe is expected to pull in the other direction. After the government in London invoked Article 50 in late March, mainland Europe made it clear that the divorce proceedings would take several weeks to get started. That afforded UK Prime Minister May the political opportunity to affirm her mandate by calling for a snap election on June 8. With the UK opposition party in disarray, the vote is expected to give the Tory PM a bigger majority in the House of Commons, and more importantly give May the stamp of popular approval after she ascended to leadership in a closed party vote last summer. If everything goes as expected, this should give the PM more confidence of domestic support during the Brexit negotiations, showing that the UK is resolved to follow through on the separation plan.

The Brexit negotiations will get underway in earnest soon after the snap election. Officials on both sides are predicting tense talks, and major points of contention are already appearing. The EU's open bid was for up to €60 billion in exit payments by the UK to cover EU budget obligations, as well as outstanding pension liabilities and loan guarantees. This demand has since reportedly been upped to over €100 billion over 10 years. London has countered that it will not pay any exit bill without a concurrent agreement on a new trade deal with the bloc, while the EU insists that trade talks come later. In the months ahead, there are sure to be some dramatic headlines leak out of the talks as both sides send up trial balloons or issue threats.

The Next 100 Days

Tough negotiations are going to be the name of the game in Washington for the next several months as well. A number of major legislation initiatives are on the front burner, but it appears each measure will have to go through the crucible of a factional Republican House before moving on to a Senate that will have to reshape the bills to attract some Democratic support in the face of remaining filibuster rules.

In the symbolic first 100 days of the Administration, the White House hasn't managed to pass any of Trump's signature policy pledges. But there are some signs that the Administration might finally be getting its sea legs, and could actually start making some headway. After the embarrassing aborted attempt to rush through an Obamacare replacement in April, the House leadership managed to scrape together enough Republican votes to pass its stripped down healthcare bill. Ultimately this may only be a symbolic victory for the House Republicans that made repealing Obamacare their central campaign issue for the last seven years. Senate Republicans are already making noises about a complete rewrite of the House bill, which could stretch the process well into next year. Republicans may get more fodder to support their pitch for healthcare reform in the weeks ahead as insurers are required to declare by June 21 whether they will sell coverage on the Obamacare marketplaces.

The biggest achievement of the administration to date may be the $1.1 trillion omnibus spending bill that avoided a government shutdown, funding federal operations through the end of September. The deal showed that bipartisanship is not dead in D.C., even though it meant putting off some of Trump's budget demands including funding for border wall construction. The budget deal demonstrated that Republicans can attract some of the Democratic votes in the Senate they will need if they hope to pass legislation on tax reform and infrastructure spending later this year. Any spark of bipartisanship was dashed, however, when the President tweeted out a threat to shutdown the government in October after he felt Democrats crowed too loudly about the compromises they had won in the short term funding agreement.

The markets could take heart if an infrastructure spending bill gets on track. The concept of a $1 trillion infrastructure stimulus package was floated earlier this year, but since then the initiative has gotten short shrift. Businesses that depend on shipping would be happy to see a capital investment plan for improving highways and bridges, but even if Congress expedites the legislation it could suffer from a lack of "shovel ready" projects and could take years to have a real economic impact.

Even if some items on Trump's legislative agenda don't make headway, markets are still counting on tax reform later this year to keep the reflation trade alive. A brief outline of the tax plan was released late last month, envisioning a 15% corporate tax rate with government revenue losses partly offset by closing tax loopholes. Taxes for individuals would also be modestly lowered and greatly simplified. Tax reform has the potential to draw in some Democratic support if the bill is carefully crafted, but nearly every line of the complex federal tax code has its own entrenched special interest supporters, so the tax overhaul may not come easy. There is also the question of the impact on government revenues and the deficit. It appears that the Wall Street wing of the White House has scuttled the idea of a border adjustment tax (BAT), a hobbyhorse of the economic nationalists on team-Trump. This is likely to leave a big shortfall in government revenue even if the promised three-percent-plus GDP growth is achieved. That could further balloon the deficit, which will draw the ire of fiscal hawks in Congress.

It remains unclear when any of these bills will reach the President's desk. After the initial false start on healthcare, the White House has learned to be more cautious about setting dates-certain. Recently Treasury Secretary Mnuchin admitted that his original timeline for passing tax reform by the August legislative break was "highly aggressive to not realistic at this point." He now says he's hopeful about passing it this year. If the process appears to stall, markets could get nervous and extract some of the "Trump reflation trade" that has already been priced in.

Arguably the Trump administration has had a little more success on the foreign policy front. Trump has ruffled the feathers of old allies with demands for more help with paying for collective defense, successfully prodding NATO allies into reviewing their defense budgets. The White House team has also been stirring the pot on 'fair' trade issues, most notably with its NAFTA neighbors. Most of the rhetoric has been aimed at Mexico, with talk of the border taxes and building 'The Wall', but Trump lowered the boom first on Canada, imposing a 20% tariff on Canadian timer. The Commerce Department is pursuing trade investigations of the steel and aluminum markets, self-initiating the process without waiting for a US company to file a complaint.

In the geopolitical sphere, Trump's strategy of approaching China to corral North Korea seems to be bearing some fruit. The Trump administration declined to label China a currency manipulator and has dangled the promise of more generous trade terms in exchange for China's help with its neighbor. China has used its position as North Korea's largest trading partner to put economic pressure on Pyongyang, enough that the state news agency recently issued a statement warning China not to "test the limits" of North Korea's patience. Some of this diplomatic progress may be undercut, however, if the White House follows through on plans to cut funding to the State Department.

Adding to the complexity of the situation, South Korea's President Park has been ousted by a corruption scandal, leaving the country rudderless even as tensions between the two Koreas are at their worst in decades. An election on May 9 will choose a new President, and the front-runner, Moon Jae-in, the candidate from the left-leaning Democrats, has called for a renegotiation of the US deployment of THAAD missile defenses. That could disrupt efforts to apply steady pressure on the North.

6 More Months

Instability is also starting to creep back into the energy market. Four months into the six-month agreement between oil producers to reduce output, crude futures seemed to level off at around the $50/bbl level. But in recent days oil has been sinking to lows not seen since last summer, before oil producers sealed the deal on their output cutting agreement. The energy market has been hit by a relentless rise in US oil rig counts, a more stable Libya getting production back online, as well as technical factors all conspiring to take WTI crude back down to the low $40's.

If the oil market continues to deteriorate it could force a flashback to some of last year's key issues. Low energy prices hampered any progress against weak inflation for most of last year. There were also concerns about energy companies collapsing in a low price environment, and worries about the banks that hold the debt of the more speculative drilling equipment companies.

All in all, the six-month production curb agreed to by key OPEC and non-OPEC nations has been beneficial to the industry, as affirmed by energy equipment suppliers who have broadly declared a trough in deliveries of rigs and other capital equipment. But with the original agreement set to expire at the end of June, all eyes will be on the May 25 OPEC semi-annual meeting. It's at that conclave that producers will make their final decision about extending the production quotas for another six months.

There are already strong indications that the deal will be extended through the end of the year. Numerous reports have indicated that Saudi Arabia and its Gulf allies have agreed the best course of action is to keep the curbs in place, and other big producers like Iraq and Russia also seem resigned to keeping a lid on production. One report suggested that Saudi is prepared to keep the cuts in place even longer, in part to keep energy prices up until after the eagerly awaited Saudi Aramco IPO in 2018.

Oil ministers remain cagy, saying the decision will not be taken until the day of the OPEC meeting. And there is always the chance that political tensions between the Saudis and Iranians will collapse a renewal agreement.

Another wildcard is Venezuela, where anti-government unrest is growing as lower oil prices have exposed the ineffectiveness of the government. Weeks of protests have moved the unpopular President Maduro to announce the creation of a new popular assembly with the ability to rewrite the constitution, which the opposition has labeled a power grab. If the protests against Maduro grow, it could lead to disruptions in Venezuela's two million barrels-per-day supply of oil and send energy prices higher. In the months ahead, Maduro could take more drastic measures to hold onto power, or he could potentially be ousted. Both scenarios would likely crimp Venezuela oil production in the short term (ironically helping prices), but if a new leader from outside of Maduro's Socialist party should rise to power, it could lead to a more free-market policy for the country that could spur significantly more oil output.

10 Months to Go

In a much less permanent way, Janet Yellen is also on her way out. With under 10 months left on the Fed Chair's term, she has turned the FOMC toward the normalization process. Despite some tentative signs that President Trump is warming up to the Fed Chair, it's doubtful that he will reappoint Yellen to a fresh four-year term. Under the circumstances, she could have easily left the heavy lifting to her successor, but it appears that Yellen is determined to maintain the collegial spirit of the Fed and get the wind down of accommodation well underway before she leaves office.

In a sense, all of the attention that fiscal policy is getting in Washington has helped bail out the Fed - now that the Fed is not the only stimulus game in town it can finally focus on a steady unwind of accommodative monetary policy. After three rate hikes off the zero bound, including two since December, the Fed seems to finally be on track to tighten policy on a more consistent basis. The baseline expectation has been set at three hikes in 2017, with the next two earmarked for June and December. Fed officials have also left the door open to a potential fourth rate hike if the economic data dictate it.

At its early May meeting the Fed acknowledged that growth slowed in Q1, but brushed it off as "transitory", echoing the seasonality seen in the early part of the last several years. The April employment report gave credence to this case, showing a strong rebound in payrolls from the disappointing March reading, and notching a fresh decade low in unemployment. But inflation remains stubbornly weak, particularly in the wage data, and could disrupt the rate tightening schedule if inflation does not make progress toward the Fed target in the next few months.

The Fed believes it can avoid a new 'Taper Tantrum' by being transparent about its plans for the balance sheet reduction. Markets showed little reaction when the central bank announced earlier this year that it had begun deliberations on how to conduct the balance sheet run off, nor in the wake of Fed officials suggesting that the taper should probably start later this year. Market participants also seemed to approve of NY Fed President Dudley's suggestion that rate hikes could see a "little pause" when the central bank starts reducing bond holdings. Rates remain the primary tool for implementing monetary policy and the hope is that the balance sheet reduction will operate in the background, at a gradual pace.

In fact, Fed discussions around the balance sheet so far have already laid out much of what the final plan may consist of. Most Fed officials appear to agree that it is optimal to start by ending reinvestment and allowing maturing securities to roll off the books organically (rather than actively selling holdings). There is also a consensus that the balance sheet should be substantially reduced over time (in part so that the Fed will have QE as a tool for future recessions), perhaps more than halving the current $4.5 trillion balance sheet over time, though still keeping it well above the pre-crisis level.

It is likely that the Fed will continue to mull its tapering plan for at least a few more weeks, so no policy position is expected until later this year. June is a likely timeframe for an announcement on the balance sheet plan, unless the Fed wants to avoid overwhelming the markets with the expected rate hike AND simultaneous taper talk. That would set up the late July or mid-September FOMC meetings (or the intervening Jackson Hole conference) as the last chances for publicizing the balance sheet plan with enough time to let it sink in before beginning the implementation toward year end.

Oversight of the banking sector, which has been a big beneficiary of higher rates, also remains on the Fed's plate. After years of streamlining operations under a near-zero rate regime, the banks largely saw stronger than expected results in Q1. They could also benefit from getting a clean bill of health in the upcoming Comprehensive Capital Analysis and Review (CCAR). The big banks have now submitted their 2017 CCAR reports for analysis by the Fed which will reveal the results of the supervisory stress tests by June 30 (exact date TBA). In the meantime the banks will have to dodge tape bombs out of Washington, such as President Trump's recent offhand remark after a community banking event that he is "actively considering" breaking up the big banks.


1: UK Manufacturing PMI; US PCE Price Index; US Personal Spending; US ISM Manufacturing; China Caixin Manufacturing PMI
2: German Unemployment; UK Construction PMI
3: UK Services PMI; Euro Zone Prelim Q1 GDP; US ISM Non-Manufacturing PMI; FOMC Policy Statement
4: US Nonfarm Productivity; US Trade Balance; US Factory Orders
5: US Payrolls & Unemployment

7: China Trade Balance; France Run-off Election
8: German Factory Orders
9: China CPI & PPI; South Korea Presidential Election
10: US JOLTS Job Openings
11: UK Manufacturing Production; BOE Policy Statement; US PPI
12: US CPI; US Retail Sales; Prelim University of Michigan Confidence

14: China Industrial Production
15: US Empire Manufacturing
16: UK CPI & PPI; Euro Zone Q1 GDP (2nd reading); German Zew Economic Sentiment; US Housing Starts & Building Permits; US Industrial Production
17: UK Claimant Count & Unemployment; Japan Prelim Q1 GDP
18: UK Retail Sales; Philadelphia Fed Manufacturing Index

23: Various Euro Zone Flash Manufacturing & Services PMIs; German Ifo Business Climate; UK Inflation Hearings; US New Home Sales
24: US Existing Home Sales; FOMC Minutes
25: UK Q1 GDP (2nd reading); ECB Minutes; OPEC semi-annual meeting
26: US Durable Goods Orders; US Preliminary Q1 GDP (2nd reading); G7 summit in Taormina, Sicily, Italy (ends May 27)

29: Japan Household Spending
30: US PCE Price Index; US Personal Spending; US Consumer Confidence; China Manufacturing & Non-manufacturing PMIs
31: German Retail Sales; German Unemployment; Euro Zone Flash CPI Estimate; Chicago PMI; China Caixin Manufacturing PMI
1: UK Manufacturing PMI; US Nonfarm Productivity; US ISM Manufacturing PMI
2: UK Construction PMI; US Nonfarm Payrolls & Unemployment; US Trade Balance

5: UK Services PMI; US ISM Non-manufacturing PMI; US Factory Orders
7: German Factory Orders; Japan Final Q1 GDP; China Trade Balance (tentative)
8: ECB Policy Statement; UK Snap Election; US JOLTS Job Openings; China CPI & PPI
9: UK Manufacturing Production

12: Japan Q2 Business Survey Index of Manufacturing
13: UK CPI & PPI; China Industrial Production
14: UK Claimant Count & Unemployment; US CPI; US Retail Sales; FOMC Policy Statement, Economic Projections, and Press Conference
15: UK Retail Sales; BOE Policy Statement; Philadelphia Fed Manufacturing Index; Empire State Manufacturing Index; US Industrial Production; BOJ Policy Statement
16: Euro Zone Final CPI; US Housing Starts & Building Permits; Preliminary University of Michigan Consumer Confidence

20: German Zew Economic Sentiment
21: US Existing Home Sales
22: Various Euro Zone Flash Manufacturing and Services PMIs
23: US New Home Sales

26: German Ifo Business Climate; US Durable Goods Order
27: US Consumer Confidence
28: German Preliminary CPI
29: US Final Q1 GDP; Japan Household Spending; China Manufacturing & Non-manufacturing PMIs
30: German Retail Sales; German Unemployment; UK Current Account; UK Final Q1 GDP; Euro Zone Flash CPI Estimate; US Personal Spending; US Core PCE Price Index; Chicago PMI; OPEC production cut agreement expires (unless extended); Fed CCAR stress tests released by June 30