The unexpected Trump victory in the recent US Presidential election has caused not only volatility, but compelling moves across global markets as traders absorb the inflationary pressure his presidency may bring.
In the immediate aftermath of the results, bonds suffered their most drastic sell-off in years and US stocks reached record highs. Asian stocks dragged themselves up from the trenches to benefit from the reflation trade, while the USD Index broke to 14 year highs.
Yield differentials have been the key driver for FX markets since Trump was elected, and are likely to remain so in the run up to the Fed’s December meeting. US yields lead the way higher which saw spreads narrow to support the Greenback and send the respective currencies lower.
As some of the dust settles, we now find ourselves in an ‘in-between’ phase that we expect will support current trends as we head into 2017, albeit with corrections in between.
The Greenback has finally paused its’ parabolic ascent following several weeks of gains, allowing investors to gather their thoughts and plan their next moves. A correction would likely be welcomed as it allows other to jump on-board the bullish bias at more favourable prices.
Economic data is unlikely to alter bullish sentiment for the USD, as expectations for a FED hike remain high and Trump is not yet in office, so we find ourselves in one of the most positive Q4 trading environments in recent years. We therefore expect global stocks to remain supported and rise as we move into 2017, and USD to correct following the FED meeting in December. Regardless of meeting we expect stocks to ignore the prospects of higher rates, as they are simply not high enough to put any meaningful pressure upon them yet.
Soaring inflation expectations have put upwards pressure on the Fed to raise rates, which raises concerns about how emerging markets will manage possible multiple hikes over the course of next year. Many emerging markets may not yet be ready to wean themselves off cheap credit, so combined with a fear of potential protectionist policies from the Trump administration, the long USD and short emerging currencies theme could remain until Trump enters office.
The lead up to the outcome of the Fed’s December meeting and Trump taking office could prove to be one of the strongest rally’s in recent years. We also expect that the meeting will lead to a USD correction, which may provide emerging markets (or anything priced in USD) a reprieve.
Traders are paying more attention to positive data and so it is hard to argue that US economic data will alter bullish Greenback sentiment before the next Fed meeting. Between now and mid-December, pullbacks for the USD are likely to be relatively minor and the risks remain skewed to the upside. We also expect USD GDP to expand, and ISM surveys are likely to suggest further support for growth in 2017. Furthermore, employment data is more likely to be skewed to the upside than the downside.
What will December bring?
With markets confidence of a hike and anticipation of hawkish Fed, the December meeting could in fact be the catalyst that stops USD rising exponentially. Even if the Fed does embark on several rate hikes over the course of 2017, we don’t anticipate that this will be strongly intimated in the results of their meeting.
This is one of the most reserved Fed governments we have ever had, and so we do not expect strong, hawkish language in their statement. Traders have placed a lot of bullish emphasis on a higher rate path next year, so if their statement is not hawkish enough, traders are likely to sell USD.
Last December, the Fed effectively started the Dollar’s decline for the next 6 months. It could certainly be argued that it is in the Fed’s interest to halt the advance of the dollar, as a fast-rising dollar not only causes global imbalances but Trump is likely to fight a higher dollar hampering US exports.
Following the Fed decision, the focus will shift to Trump’s impact on the markets when he officially arrives in office. Whatever his chosen course of action, stocks are likely to survive any major sell-off as US rates are nowhere near high enough to cap gain, and economic data continues to suggest growth ahead.
Barring any new extreme information, recent trends are likely to remain supported overall. We are therefore lucky that this December, Santa’s rally is more likely to impress this year than disappoint, as it has for the last two. Unless of course, it came early in November, yet we still see downside as limited compared to gain witnessed of late.
Matt Simpson is a Senior Market Analyst at ThinkMarkets.com