Having suggested that the Trump Presidency may be framed through the prism of 1980's nostalgia in the last report, this thesis must now be put to the test. The British Foreign Secretary became the most recent Cabinet member to embrace the back to the Eighties feel of emerging Anglo-American relations. The Foreign Secretary was the first foreign official to receive a telephone call from Vice President Pence, which prompted him to enthuse that the Special Relationship is going to be called henceforth the "Spectacular" Relationship. Prime Minister May was more circumspect, preferring to use Trump's election victory as justification for her adopting a populist Brexit stance. She alleges that this is an opportunity to make "capitalism work for everyone". Populists however vote primarily on the issue of whom "everyone" refers to and not capitalism per se. "Everyone" is polite code for not foreigners; so despite her circumspection, the element of aligned interest between the two political leaders is ostensibly visible.
So aligned is the respective interest of each nation in fact, that the Prime Minister specifically said that there is no room for the President's Brit Buddy Nigel Farage. Rumors have been circulating that President Trump will brief UKIP's ex-leader Nigel Farage in advance of all his discussions with the Prime Minister. If these rumors are true, then President Trump intends to try and engineer regime change in Britain to become more representative of American interests than it currently is.
(Source: Business Insider)
The analysts at Citi seem to be of the confirmed opinion that it will be like the 1980's again. Where this author differs is that he sees the current rise in Treasury yields and the US Dollar as creating a slowdown early in Trump's presidency, that is then used as the catalyst for the big fiscal stimulus combined with a monetary policy expansion by the Fed.
(Source: Business Insider)
The spike in Treasury yields above equity yields, signals that the inflection point for the economy has just been triggered even before the new President is sworn in. Rising yields now effectively become the trigger for an economic slowdown, rather than a signal of growth ahead. If the Fed follows the steepening curve, by hiking interest rates, then the trigger becomes all the more effective. Rather like his predecessor the incoming President will then be faced with weakening economic conditions, potentially exacerbated by his protectionist rhetoric. Faced with this environment, the probability of combined monetary and fiscal stimulus is high.
The recent violent equity rotation, from technology to US domestic based industries, had more of an element of panic about it than the explanations offered by commentators. This was in part a flight to safety in anticipation of tough economic times, of rising interest rates and inflation ahead, as much as it was a search for Trump-Alpha. Mr Market is now agonizing over whether to correct in line with Treasury-Equity yield gap and anticipate a slowdown; or to move on higher in expectation of the Trumponomic and Fed stimulus reaction to said slowdown. Given that there is the greater part of $ 4.5 Trillion in QE still sloshing around the capital markets, any slowdown in the real economy will not be as severely felt in the financial economy. The response by the Fed and the Trump administration will however have a much greater impact on the part of the financial economy that is associated with the stimulus; hence another reason behind the recent great rotation into domestic American stuff-stocks.
In relation to American inflation, there is also something in the ground that was previously unavailable when the great inflation occurred in the late 1970's/early Eighties. America now has Shale Oil and Gas in abundance. In fact, it has just discovered a field the size of Saudi Arabia's giant Ghawar field in the Permian Basin beneath the West Texas Desert. The probability of another inflationary Oil Shock to the domestic economy has been significantly lowered, whilst great progress continues to be made in scalable cheaper alternative energy sources.
The last report suggested that rising bond yields and a stronger US Dollar would slow the US economy, at the same time that Trump's trade policies would bake in a little domestic inflation. Goldman recently came to a similar conclusion, in one proposed scenario which they named Stagflation. The probability of the Stagflation outcome is directly correlated to the strength of Trump's trade and fiscal policy mix. The prognosis of the Bank for International Settlements (NASDAQ:BIS) is a lot more chilling. It sees the innate US Dollar strength, in reaction to the Trump presidency, as signifying a significant decrease in global risk appetite that may then lead to global a economic slowdown.
Increased political influence over the Fed was anticipated in the last report. The early indirect signs of this have emerged from President Trump's economic advisers. On first impressions, they wish to see the current monetary stimulus withdrawn and the Fed's balance sheet shrunk over time. Ironically, this view therefore drives up yields and withdraws liquidity in a way that acts as the kind of economic headwind envisioned by this author. Presumably these advisers buy into the story that the Trump fiscal stimulus will be of a magnitude that overcomes this stimulus. They are also conveniently related to the lobby group that is currently weakening Dodd-Frank, in the hope that the commercial banks will avail themselves of the higher lending margins created by the Fed exit and pick up the traditional economic heavy lifting. There is certainly something self-fulfilling and self-enriching about their embrace of monetary and fiscal policy imprudence. There is however a deeper theme of monetary and fiscal imprudence beneath the tip of the Trump policy iceberg that is floating into the path of the American economy. This is far more sinister.
Perhaps the strongest signal came from President Trump's "Grand Wizard" Steve Bannon. Fearful minorities may be breathing a little easier in the knowledge that the first intended lynchings will be of the bond-owning rentier class. Reprising Andrew Jackson, Bannon wishes to use negative interest rates to finance the new Confederacy that President Trump is going to build. This outcome may have to wait until the bond vigilantes have had their say first through higher yields, that push the economy into the slowdown that negative interest rates can then be applied to. Janet Yellen's reaction to such a declaration of intentions and capabilities should be watched carefully.
Yellen's chair position is up in 2018 and her position as a Fed Board member in 2024, so Trumps immediate options in relation to her are limited. He has a window of opportunity to appoint two vacant Governor positions immediately, but the lengthy term structure of Governor and regional President employment contracts and the Fed's charter limit the opportunity for more blunt surgery. The Fed was structured precisely to prevent this kind of executive interference. Trump will probably sit on his hands and rage at the lack of cooperation from the Fed, until the economy slows to such a degree that he can then engage the Republican controlled Congress in some discussion about direct legislative changes to the central bank. By then the Fed will no doubt have embarked on its next wave of monetary expansion, so the need for radical intervention will have been avoided. The Fed is more use to Trump left alone as a scapegoat and punch-bag for now.
In the last report, Minnesota Fed President Neel Kashkari was observed building bridges of trust between the Fed and the Trump administration. This process ended prematurely when he unveiled his plan to end Too Big To Fail. In effect he wishes capital standards for systemically important financial institutions to be so high that they will have to break themselves up. Assuming that the President is going to go with a big stimulus plan, he has no room for small banks. This fact in addition to the ways that Wall Street has got its eyes on the Treasury Secretary position and Financial Team Trump is dismantling Dodd-Frank, signals that Kahskari's plan is going to meet strong resistance.
The bridge building process was then nudged along by St Louis Fed President James Bullard. Firstly, Bullard hailed the election result as breaking the gridlock in Washington that has frustrated economic growth policy action. Bullard's optimistic spin frames the Fed as having nothing to worry about, because the earliest that Janet Yellen can be removed is 2018; and also because the central bank's structure of seven governors serving 14-year terms and 12 regional bank presidents means the institution will remain "at arm's length" from political influence. He also sees that the President has got bigger fish to fry in terms of fiscal economic stimulus than to interfere with the Fed. In reference to said stimulus and the Fed's reaction to it, Bullard noted that it has the potential to create growth worthy of several rate increases but also that it is still too early to envisage this. He is still fundamentally one rate hike and done, which is administration friendly.
Looking objectively at Bullard's words, through the context of rising bond yields, one can discern the pattern of a trap for Janet Yellen. Rising yields may slow down the economy from here on out into 2018. Yellen could then be blamed and "fired" Trump style for the slowdown. This risk was further outlined by Richmond Fed President Jeffrey Lacker, when he opined that the expected Trump fiscal stimulus will accelerate the pace of interest rate hikes. Kashkari then continued to build his bridges, with toned down rhetoric, when he said that the Fed would have to "wait and see" in relation to the expected fiscal package.
Interestingly, Kashkari's tone has also been adopted by Fed Vice Chair Stanley Fischer. His attempt to build bridges with the Trump administration began with an attempt at honesty by admitting to be surprised by the election result based upon the poll and media predictions. He welcomed the expected fiscal policy expansion as raising the neutral rate of interest; yet cautioned that it is still premature to make conclusions about any fiscal plan. Fischer's path to Fed Chairmanship is therefore being carefully constructed by his own words, or at least his chances of getting sacked along with Yellen have been diminished. Having ingratiated himself, he then went through the task of discrediting Chairman Yellen's overheating thesis in order to promote his case. In his opinion the economy is very close to reaching the point at which the Fed will have achieved both its mandates. He stopped short of signaling a rate hike in December, to buy himself time and flexibility.
Least surprising of all was the alacrity with which New York Fed President Bill Dudley responded to the attempts to dismantle Dodd-Frank. His position is that he will accept incremental changes to it, without a full reversal at this point in time. The New York Fed's bailiwick is Wall Street, so it is effectively a prisoner of what used to be known as the money-centre banks. Dudley was therefore able to kill two birds with one stone, by promoting the interest of the banks and building a bridge between the Fed and the Trump administration. He responsibly opined that a repeal should not take the banks back to where they stood before the Credit Crunch in terms of risk. Once the process of repeal is instigated it can go through several stages of dilution so that ultimately the result will resemble the situation pre-Crash.
Dallas Fed President Robert Kaplan seems to be increasingly worried by the headwinds from rising bond yields and the stronger US Dollar. His views are interesting, given that he comes from a state where Trump trounced Clinton. For him the jury is still out on the impact of a Trump win, so the Fed must presumably stand pat in December. In the past he has asked for more eclectic growth policies than blunt fiscal stimulus. In particular, he has asked for pro-population growth policies; which Trump has ostensibly curtailed with his anti-immigration stance. Clearly Kaplan understands that blunt fiscal stimulus, at this level of debt, simply drives yields higher which then blowback against the stimulus. His circumspection is noteworthy and speaks to the Stagflation risks highlighted by Goldman earlier.
Fed Governor Daniel Tarullo was even more explicit than Kaplan about the Fed hiking prematurely, in the face of capital market tightening, with no details of Trumponomics. In Tarullo's words: "We don't want to be pushing on the brakes harder than we need to," …. "fiscal policy is one of the important background considerations...Give the administration time to propose its program and Congress to decide."
Boston Fed President and Dove turned Hawk Eric Rosengren's recent pivot to the dissenting camp has put him into a corner from which he will find it hard to escape. His latest media platform for guidance saw him grasping at the straw of the expected fiscal stimulus as a crutch to uphold his support for a December tightening.
Philadelphia Fed President Patrick T Harker articulated the conventional response in relation to the expected December rate hike in the new Trump era. Whilst agreeing that it is now more likely, he questioned whether the expected Trump fiscal stimulus will actually require a more aggressive tapering.
Cleveland Fed President Loretta Mester added a note of independence to the conventional message of Harker. In her opinion it would be premature to speculate and even act in anticipation of President Trump's economic plan; and it would also be immature to overreact to the current market volatility that his victory has created. She therefore remains on the default baseline of immediate but then gradual interest rate increases.
The spirit of Democrat resistance to Trumponomics, symbolized by Fed Governor Lael Brainard, lives on despite the existential threats to its existence and influence. Brainard's resistance has become passive-aggressive, in place of her previous overt stance. It should be remembered that she was the key figure, who opined on the international impacts of interest rate increases, which ultimately tempered FOMC enthusiasm to tighten earlier in the year. She has now reinvented herself by embracing the study of the "gig economy" which structurally blows disinflationary headwinds to the consumer whilst simultaneously blowing tailwinds to corporate profits. Her embrace of the structural disinflationary impact on the workforce, in its agency role as a consumer, signals that she has understood the plight of the little guy which propelled Trump to victory. Brainard is thus very much a populist, however she will channel perceptions of her stance towards the Democrat cause. She can thus maintain her Dovish position and make it into a Democrat position if and when the economic data support this view.
Janet Yellen was back to her old composed and collected self, after a recent mini-meltdown in the eyes of a divided FOMC and hostile Washington audience. It would appear now that, her colleagues have understood that the Fed is truly under threat, they have rallied around her and settled their own internal friction. Feeling less threatened from within, she now projects and external image of calm and control. Acknowledging and conceding to the dissenters, she hinted that a rate increase is coming soon. However playing on the growing fears that the Fed may fall into the carefully constructed Trump trap, of tipping the economy into recession, she opined that the recent good economic times are not expected to last. In doing so, she opened the window of opportunity for collaboration with the Trump administration in accommodating a future fiscal stimulus.
Of all the Fed speakers last week, Governor Jerome Powell's words were perhaps the most enlightening as to how the Fed-Trump administration dynamics will play out. Powell is a permanent voting member, so his position is meaningful. Despite the fact that he did not specifically refer to the upcoming interest rate debate in December, his vision of the future hinted at how the Fed may now have to abandon some of its global responsibilities in response to the shadow of President Trump. He stated that the process of globalization has been arrested. His advice to the Asian economies, that will suffer as a result of this, is that they should stimulate their domestic economies. Evidently the Fed is less inclined to make policy for the global economy from now on; which is a big change from the spring of this year when it abandoned the rate hike process in response to Brainard's persuasion based on the global risks from the Taper Tantrum.
The almost 100% certainty that the Fed will hike in December underlies the thesis of the risks from growing headwinds even before the full details of Trumponomics are known. No doubt this kind of certainty and discounting by Mr Market have got Robert Kaplan and Daniel Tarullo feeling uneasy. This full discounting combined with the emerging concerns at the Fed signal the Mr Market has become overly pessimistic and due for a period of second guessing himself.
The spike in mortgage rates has similarly delivered an economic headwind before the details of the expected Trump tailwind are clear.
Mr Market and several Fed officials seem to believe that there is a shovel ready infrastructure fiscal stimulus at hand. President Trump has given no specific indication that this is the case. Such spending then has to go through a long process of evaluation and then ordering to get the most bang for the fiscal buck. Even though Congress is onside this is still a time consuming process. Rising interest rates also raise the hurdle for return attractiveness and increase the cost of Federal funding. By the time that such a process has been followed, higher interest rates may have already slowed the economy in addition to raising the cost for such a stimulus plan to make it look unattractive in anything other than political optic terms. Monetary inflation from a friendlier Fed would make the process a lot easier, by reducing the funding costs and providing a trustworthy buyer of fiscal stimulus bonds to inflate away the burden on the Federal Government. Perhaps Trumponomics is nothing new after all and "deficits don't matter" as a famous Republican once said in the 1980's.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.