Making Dissonance Great Again

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Summary

The more than passing resemblance of President Trump's posturing and the behavior of President Reagan is causing parallels to be drawn.

Analysts are uniformly bullish on the outcomes of either watered down or fully implemented Trump policies.

America, Inc. is not sincerely committed to make America great again.

Rising yields in US dollars and the stronger US dollar are headwinds that have triggered deleverage and reduced capex.

Bernanke advises the Fed to engineer a yield curve bull flattening to sustain the economic expansion.

(Source: Bloomberg)

As the search for confirmation or denial of the thesis outlined in a previous report that the 1980's period is a good frame for viewing the unfolding Trump years, the signals of cognitive dissonance have begun to come in.

(Source: Bloomberg)

Confirmation of the 1980's theme can be found in the commentary from the great investors like Ray Dalio, who said that this will be a period of "profound president-led ideological shift" akin to that of Ronald Reagan. The parallels may be a source of disappointment for the most militant of Trump's supporters however. In the final analysis, President Reagan fell well short of the radical agenda that he had promised during his campaign. In many ways, the current backstroking by the president-elect signals an even stronger comparison between the two presidents.

Significant backstroking on campaign promises, the most obvious being the promised Muslim registry and the prosecution of Hillary Clinton, sets up the dissonant tone. The "trumpeted" deal with Carrier to keep jobs in the USA was long on headlines, short on substance, and not scalable across the whole manufacturing industry. Next up, Paul Ryan dropped the bombshell that the wall across the border with Mexico would not be continuous or contiguous. The president-elect has rapidly eschewed some of his most winning promises. Some of this dissonance can be rationally explained by the President's need to compromise and unite the nation. There are however exceptions to this general unification theme.

The hyperbole from the sell side of Wall Street has set up a dissonant tone in the capital markets. Analysts are uniformly optimistic that President Trump's policy will lead to a renewed economic expansion and equity bull market. This optimism is generated by those who believe that he will renege on his promises and thus avoid a global trade war; and conversely by those who think that his religious delivery on all his promises will create a domestic economic boom. The coin is double-headed, and the head outcomes are thus positively asymmetric; assuming that one calls heads. Calling tails is a totally different game!

In relation to the expected interference with the Fed, the analysts are equally as optimistic in the belief that Dodd-Frank will be eviscerated. The return to irrational exuberance is therefore systemically guaranteed. President Obama has so far left the vacant chair of Fed Vice-Chair for banking supervision open, because he understood that the Republicans would fight him on a political appointment. The analysts now seem to think that this position will get filled by President Trump with a captive ex-Wall Streeter. With Dodd-Frank in the shredder and a Wolf of Wall Street in the regulatory henhouse, it is apparently a fait accompli.

The potential for disappointment in the near term is therefore large, especially in view of the fact that there have been no policy specifics announced and the President appears to be in no rush to release anything more than broad brushstrokes.

(Source: Bloomberg)

A specific area of cognitive dissonance worth watching carefully for key signals about the economy surrounds the campaign issue to encourage the repatriation of overseas profits. The devil as always will be in the details, which are absent at the moment. Looking into the future, Goldman Sachs sees corporate cash hoards being spent on share buybacks and not capex. There can be little doubt that the cash will get repatriated because fear of trade wars will make it nervous about being attacked by the fiscal authorities and populist governments in these foreign nations.

In the last report, Goldman also opined the potential for Stagflation. This outcome can thus be put into the context of companies raising domestic prices, behind the Trump erected trade barriers, whilst failing to expect domestic economic capacity through capex. Corporate profits come at the expense of consumer inflation. Consumer inflation is an economic headwind; and thus Stagflation becomes a self-fulfilling prophecy. Those foreign jobs are therefore not coming home as promised after all. This is the first dissonant signal that America, Inc. does not actually intend to participate in making America great again. In fact it only wishes to make its share prices great again through financial engineering rather than economic production.

Should repatriation of foreign profits be allowed without any conditions of real domestic investment attached to them, the share-buyback wave will be even larger. Share prices will thus have an even more tenuous relationship to the domestic economic reality. Rising bond yields will then exaggerate the yield premium of fixed income over equities. Companies will therefore use their cash hoards to deleverage, especially in view of the fact that rising yields are an economic headwind. Corporate behavior in addition to the Fed will thus be ushering in an economic slowdown. The net result will then be that a combined fiscal and monetary policy expansion will be required to restart the economic expansion. The Trump era is therefore more likely to come in with an economic whimper rather than the expected bang. The bang will be a delayed reaction to this whimper from the Treasury and the Fed.

(Source: Bloomberg)

The circumspection which adds to the cognitive dissonance is even greater from JPMorgan. Morgan sees the initial fiscal stimulus mainly coming from tax cuts and not spending. American consumer behavior since the Credit Crunch has changed. Given that the popular vote was for Clinton, there is a significant majority of consumers who are not euphoric and definitely lacking in the animal spirits that consumer booms are made of. Tax cuts may therefore lead to consumer deleveraging, especially as interest rates are rising, rather than increased consumption. This first Trump stimulus may therefore not move the needle, paving the way for something more meaningful later.

(Source: Bloomberg)

The thesis that the frame of reference for the Trump presidency is the 1980s seems to be receiving its strongest rejection by those who see the corollary impact in emerging markets. Former BIS chief economist William White, who predicted the fallout from America's credit bubble with unnerving accuracy, now sees Asian emerging markets as most at risk. For him it is specifically becoming a 1997 situation. Emerging markets were in their infancy in the 1980s, however, today thanks to globalization, they have become more important. Their importance can be seen in the Trump victory since he campaigned with a policy that will ostensibly hurt them to the benefit of domestic US industry. For those who are focused purely on the emerging market impact of the Trump presidency, it is therefore more like the 1990s. For those who see the bigger picture, both views are of the same thing.

It is interesting to compare and contrast the duality between the 1980s and the 1990s because President Clinton was ostensibly creating the trends that President Trump is ostensibly going to reverse. It is thus fair to say that those who see the 1980s in America and those who see the 1990s in emerging markets are looking at the same thing from different perspectives which in fact confirm each other.

(Source: Bloomberg)

Picking up on White's thesis, Citigroup already sees rising US$ yields and the rising US dollar creating deleverage and capex cuts from global US dollar corporate borrowers. The inflection point that triggers the economic slowdown that welcomes President Trump has thus been spotted globally. Investors in bank stocks who see the rise in lending margins through rising US interest rates, driving bank profits should take note of this headwind.

France seems to have caught the spirit of the 1980s flowing through the veins of its oldest ally America and its oldest foe Britain. The "November/December Surprise" in France of the strong showing of Thatcherite presidential candidate Francois Fillon and the resignation of President Hollande, follows on from "June Surprise" of Brexit and the "November Surprise" in America. Pretty soon the conspiracy theorists will be connecting the dots to some sinister global regime change, attributable to some equally shadowy elite group of industrialists, financiers and national security operators. Signaling a closer shadowing of American policy, Chancellor Hammond announced a new roadbuilding programme in his Autumn Statement. Will this trend continue with infrastructure spending in the other nations that fall into line with the new global regime change?

(Source: Bloomberg)

OPEC also seems to have caught the spirit of the 1980s. The recent agreement to disciplined cuts, which no doubt will get cheated on, amongst sworn ideological enemies within the cartel owes much to their collective fear of what President trump means for their political franchises. They have assumed that a strong oil price is good for their franchise and therefore not good for President Trump's alleged carbon intensive economic policies.

Ironically, OPEC has played into President Trump's hands by making America's abundant shale oil and gas reserves economically competitive again. US shale producers then used the OPEC rally in crude to hedge their production out to 2018, leaving OPEC collectively with a problem of lost market share with no potential upside in price for the next two years. OPEC is betting that Trump's stimulus will boost the oil price whilst domestic Shale producers beg to differ.

Janet Yellen, Bill Dudley and most recently Stanley Fischer have all spoken in order to address potential dissonance between the Fed and the Trump administration. The specific issue of dissonance is expected to be in relation to the Fed's response to the expected Trump fiscal stimulus. These three Fed officials are now all on record for opining the Fed's position. Any fiscal stimulus should directly improve productivity in order to prevent the Fed from overreacting with tighter monetary policy. Indeed, Fischer elaborated that the Fed could also be more leisurely about its withdrawal of its monetary stimulus if the fiscal stimulus was linked with productivity policies. Clearly, the Fed is worried that Trump's policies to bring jobs back to America and then insulate them behind a protectionist wall will lead to wage push inflation. Given that the economy is operating near its current full capacity these concerns are valid.

Fischer's view sounds reminiscent of the words structural reform that are currently being used by the BOJ and ECB in relation to potential future respective fiscal stimulus in their jurisdictions. The terms of the relationship between the Fed and the Trump administration have thus been constructed around the issue of productivity (structural reform), at least as far as the Fed is concerned. What President Trump makes of these terms remains to be seen. Any sudden appearance of the words supply side in his lexicon will not only jive with the 1980s' thesis, but also confirm that he has taken on board what the Fed is saying about productivity.

The Fed continues to make pro-active steps to build bridges with President Trump and thus to avoid political interference. In its latest move, it extended the period during which former Fed officials must stay on garden leave, before moving to financial services companies that they may have regulated during their Fed service.

Dallas Fed President Robert Kaplan is establishing a more balanced rapport with the new administration by remaining vigilant about the physical impacts of the expected fiscal stimulus rather than rushing to pass judgment through aggressive rate increases in anticipation of the outcomes.

Fed Governor Jerome Powell is less concerned about building bridges and more concerned about dealing with the here and now. He recently signalled that he will vote to raise interest rates at the December meeting, because for him the risks in continuing to be patient are now greater than the benefits.

Similarly to Powell's, Cleveland Fed President Loretta Mester's mission is narrowly defined to raise interest rates asap in total independence from any political intervention. In her opinion also, failure to move soon will risk an overheated economy that requires larger interest rate increases later, which then put the economic expansion at greater risk. She thus believes that swifter interest rate increases will prolong the economic expansion.

New York Fed President Bill Dudley has taken a more nuanced approach to establishing a working relationship with the Trump administration and Congress, which involves probing the weaknesses of those who would interfere with the Fed. Focusing on the issue of Too Big To Fail, he opined that there are still significant risks from the systemically important financial institutions that require further work to be done in terms of legislation and regulation. Since Team Trump has been noted for its overweighting of Wall Street interests and the President has sworn to dismantle Dodd-Frank, there is clearly a risk that the financial system returns back to its self-regulated systemically risky worst behavior. Since much of Trump's grass roots support is anti-Wall Street, Dudley has aligned with them. Congressional interference with the Fed therefore is now in danger of being labeled as Wall Street's interference. If this were to occur, yet another Trump promise would be seen to bite the dust.

(Source: Seeking Alpha)

Ben Bernanke is alarmed by the FOMC's handling of the rate increase process. Having boxed itself into a trap by steepening the yield curve and rallying the US dollar with guidance, so that it has effectively tightened monetary conditions, the FOMC now risks tightening for real just as the economy slows in reaction to its threats. Although he would never admit it, Bernanke has observed that guidance combined with confirmatory policy action is overkill if it is left pending for too long in the name of gradualism. When the Fed has guided, Mr. Market has got carried away with discounting, and then when the Fed has delivered Mr. Market has got even more carried away. What is need is that fondly remembered and ephemeral bull market yield curve flattening that sustains the equity rally. Bernanke would like the FOMC to seek out this mythical creature.

Bernanke's solution is for the FOMC to underestimate the strength of the economy with its Dot Plots at the next meeting, thereby easing monetary conditions as the yield curve discounts this softer economic forecast i.e. your bull flattening. It will however take the acme of skill in guidance to stop Mr. Market reading the curve flattening as a recession signal. Even if this fails, he can be persuaded to flatten the curve by anticipating the recession and ensuing easing though; so it's not all bad and the outcome is guaranteed at some point.

An alternative would be not to guide at all and simply to act, but the Fed's embrace of guidance as a policy tool has effectively ruled this option out. The Fed therefore has to engage in rhetoric and counter-bluff with its communications. The problem with these plays on words is that they get misunderstood by Mr. Market. In the past, the Dallas Fed has advocated less talk, with more gravitas and real action. Thus far, this suggestion has not been taken on board by the Fed. Loretta Mester is perhaps the one who clearly understands the real risk of waiting too long after giving guidance, which is why she is in a hurry to get the next rate hike done and dusted. Despite the flexibility that the FOMC's gradualism has achieved, this has not been without the cost that Mester has identified. Talk is not only cheap, but also counterproductive and ultimately more costly, if the FOMC is not prepared to walk the talk in a reasonable time after opening its collective mouth. The Fed has yet to get to grips effectively with its guidance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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