HIGHLIGHTS OF THE WEEK

  • Economic data this week remained consistent with the theme of an economy nearing full employment.
  • Headlines were dominated this week by rising tensions with North Korea and the increased odds that the French Presidential elections could result in the victory of an anti-EU candidate.
  • Comments from President Trump’s interview with the Wall St. Journal imply that tax reform is now secondary in importance to health care reform. Less scope for fiscal stimulus may imply a more gradual process of monetary policy normalization than previously anticipated.

 

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REFLATION TRADE FIZZLES AS GEOPOLITICAL RISKS RISE

There was little in terms of data this holiday week to move financial markets. February data from the job opening and labor turnover survey (JOLTS) showed an uptick in job openings, a downtick in new hires, and a reversal of previous month’s strength in the separations rate. Similarly, initial claims data for last week held near historic lows, further corroborating the theme of a healthy labor market. The key message permeating the data is that the job market is nearing full employment, yet more reason to look past last week’s disappointing payrolls number.

In addition to the labor market data, updates on small business sentiment and producer prices were released. The NFIB’s optimism index cooled for the second consecutive month, but small business remains highly optimistic by historical standards. Growth in core producer prices meanwhile, remains consistent with gradually rising price pressures. Although producer prices in March fell on a month-on-month (m/m) basis, the move was largely driven by energy prices, leaving prices for the final demand goods excluding food and energy category rising by a firm 0.4% m/m.

Overall, there was little change in economic fundamentals this week to motivate the shifts in financial markets, which were drowned out by geopolitical developments and apparent shifts in domestic policy.

News out of North Korea dominated headlines early this week, with fears of an imminent confrontation between the U.S. and the pariah state contributing to a selloff in risk assets and a strong bid on safe havens such as Treasuries and gold. There was initially hope that the meeting between the Presidents of China and the U.S. last week would reduce tensions, but the subsequent bolstering of America’s military presence in the Korean peninsula has resulted in the opposite.

Markets also became concerned with the French Presidential election, which has seen a surge in another populist, anti-EU candidate in polls for the first round of elections set to take place in ten days. Jean-Luc Mélenchon, a far-left socialist candidate, is nipping at the heels of third placed Francois Fillon, and his momentous rise in the polls has raised the odds of a presidential runoff election in early May between two anti-EU candidates.

On this side of the Atlantic, President Trump’s comments in an interview with the Wall St. Journal suggest a shift toward more conventional policy. For one, President Trump advocated for the need to accomplish healthcare reform before tax reform. President Trump also backed off on plans to label China a currency manipulator, and expressed concern that the strong U.S. dollar has been hurting American exporters. He also reversed his view of the Export-Import bank, suggesting that it was “… a very good thing. And it actually makes money, it could make a lot of money”. Lastly, he appeared to soften his stance on the Federal Reserve’s policy of low interest rates.

These statements altogether suggest that stimulus from tax cuts is less likely in the near term. Less scope for fiscal stimulus may imply a more gradual process of monetary policy normalization than previously anticipated. Add into the mix elevated geopolitical uncertainty and it looks more and more like the reflation trade’s days are numbered.

Fotios Raptis, Senior Economist

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