While the State of the Union address is rarely a significant market-moving event, in light of recent comments by both President Trump and Treasury Secretary Mnuchin and with global trade suddenly on everyone’s radar, if there is one market-sensitive topic that may get a kick start tonight at 9pm it is both the deficit funding needs of the US, should Trump unveil more details of his debt-requiring infrastructure project and US trade relations with China (and Beijing’s potential retaliation-liquidation), especially since as Cumberland’s David Kotok observes, “markets today are much more worried about rising bond yields and trade wars.”
Earlier, we laid out some of the key items expected to be addressed by Trump tonight. In this article, we share some perspectives, considerations, concerns and general observations how markets may react to Trump’s annual address from Wall Street analysts, starting with Citi, which has a relatively sanguine view of how traders will respond to Trump, writing that from a 30,000ft perspective, the State of the Union address is rarely the venue in which policy specifics are discussed. Rather it is an opportunity for Presidents to reflect on developments over the past year and spell out priorities for the coming one.
This is consistent with recent guidance from US officials, with media reports suggesting the President will review accomplishments from his first year in office, before calling for action on issues such as infrastructure spending, the opioid epidemic, trade and immigration. This likely fits close to market expectations coming into the speech and it would be surprising if the President offered any additional layer of detail on proposals. This means that the speech may ultimately not be seen to contain a great deal of new information.
Still, the market’s immediate response is likely to be driven by two considerations:
- Whether the speech provides clues on the likely sequence of policy moving forward.
- The tone of the speech in weighting ‘business friendly’ policy such as infrastructure spending vs. more contentious issues such as trade.
As Citi continues, a speech emphasizing that infrastructure spending is the first priority and stressing the ‘America is open for business’ message from Davos would be seen as more USD positive than one putting infrastructure spending further back in the queue and emphasizing likely breaks in trade policy. Here, market expectations are closer to the former following the President’s remarks at and around the World Economic Forum, but this may understate the risk that President Trump will revert to a more hawkish tone on issues of trade. This simply comes down to the venue, with the President’s Davos remarks surely to have at least partly been shaped by the ‘globalist’ nature of the gathering.
That said, Citi concedes such considerations should ultimately prove second tier. Investors might also factor in some degree of additional expectation for fiscal stimulus should there be clarity on precise proposals on infrastructure spending, but the political timetable remains unfavorable to immediate action. To be sure, much of the legislative oxygen in the immediate future will focus on issues around the budget, immigration and the debt ceiling. Especially the debt ceiling.
Then, as the year drags on, the encroaching mid-term elections arguing against major moves. Similarly, even if the President tacks back towards the more muscular stance on issues of trade that appeared to be forming at the beginning of this month, there will remain far too much uncertainty on implementation for investors to trade on this basis for the time being.
Citi’s trade reco: while Trump’s speech may see sharp intraday moves in FX in real time, the bank doubts it will go far to shifting ongoing trends. Thus, the tactical trade on the speech is likely to fade a sharp response, particularly one towards USD strength, which could prove short-lived.
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A less sanguine take comes from Deutsche’s FX strategist Alan Ruskin, who as we previously noted, warns that there is a potential market sensitive topic its US trade relations with China. While there is much more in our original note on the matter, Ruskin believes that the likely upcoming US attack on China trade policies is apt to have broader bipartsian support than many other US trade measures.
Whether or not it will transition into a full-blown trade war remains to be seen, but in the immediate future a trade dispute with China has the capacity to impact markets through a variety of channels that includes:
i) choking global supply channels;
ii) inflating prices;
iii) influencing China’s global asset allocation, that could impact all of US bonds, equities and the USD negatively.
Of course, China knows all of this, which explains the recent trial balloons by China and Bloomberg that Beijing may slow down, or even reverse, its purchases of US Treasurys.
What could stop a collapse in trade relations?
On Monday we suggested that one such option is a market crash: as Deutsche predicts, a sharp uptick in US equity volatility is one of the few factors that could put a brake on this US push forward to change trade relations with China, and the above fits with a world of greater equity vol.
In fact, some are wondering if today’s market selloff is not endogenous, but rather prompted by “foreign actors” who are using today’s market session to send Trump a preemptive message not to take the topic of trade war too far.
What would be the FX impact should Trump decide to proceed with firing the next trade war shot? According to Deutsche, while the US attacking China’s WTO transgressions could be seen as encouraging of more CNY appreciation, in the longer-term this could prove both CNY negative and negative for most Asia EM FX. Short CNY/JPY would work under a risk-off environment, and has the added bonus that it offers some protection against a China official exodus from US bonds (if the politics turns unexpectedly ugly), with the yen one alternative reserve asset destination.
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Finally, a far more detailed, if fact-based, take of Trump’s SOTU address comes from SocGen, which takes us through Trump’s policy priorities and agenda items.
Trump’s SOTU: A Look Ahead
Summary: Trump’s State of the Union address sets priorities for his second year. Trump is buoyed by passage of the tax cut, economic momentum and a strong equity market.
Agenda items include infrastructure, trade, immigration, deregulation and national security. This preview gives some of our thinking heading into the SOTU address.
Trump should appeal to bi-partisanship in the State of the Union (SOTU). The agenda needs bi-partisan input, but reality should prove more cumbersome. A budget is still needed by 8 February and a debt limit increase is needed by early March. Meanwhile, it is an election year. Mid-term elections could cost the Republican Party the House of Representatives and the Senate.
Budget tied to immigration
Trump may very well get funding for a border wall with Mexico. Congress would approve the plan to provide a path for citizenship for DACA individuals (Deferred Action for Childhood Arrivals). The base of each party abhors the offers under discussion, but a path for citizenship and stronger security are tradeoffs Washington can accept. The government shutdown and debt limit will be closely tied to reaching a compromise on immigration.
Agenda items are expensive… and deficits are projected above $1trillion for 2019 and beyond
Infrastructure and national security can add substantially to the deficit. Republicans with some bi-partisan support are ready to approve significant funding increases for the military. Most Democrats want increased caps on non-defense spending as well. Spending plans and funds for disaster spending after devastating earthquakes require super-majority approval from Congress to surpass budget caps, or else the government faces sequester. Infrastructure proposals suggest $200bn of government money that can feed public/private initiatives that could provide more than a trillion in spending. At best, the restrictions of budget caps will be weaker, meaning no drag from curtailed spending. We are not ready to raise growth forecasts on infrastructure yet.
Controversies – Russia, obstruction of justice and racists remarks
There is no reason for Trump to raise these issues during the SOTU address. Nevertheless, these issues are part of a subtext that opponents will hold to in this election year.
Elections – Mid-term elections could be a Republican setback
Incumbents are leaving Washington. In terms of seats up for election this November, there are more Democrat seats than Republican. With a wave of retirements, incumbents are leaving many of these seats. Elections since November 2016 in Alabama, Virginia and New Jersey went Democrat. Each of these may be a special case, but the trend raises the stakes considerably for this November’s congressional elections. The result could make a lame-duck of President Trump for the remainder of his term.
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Infrastructure – Growing the role of the Federal government and even an optimistic scenario will take time to reach economy
If it passes. Infrastructure may be a big legislative push in 2018. President Trump is a big supporter. He might get a better response from the Democrats if they are willing to work with him. Many deficit hawks in both parties will be less enthusiastic about supporting new spending, particularly after tax cuts and an increase in budget caps in order to spend on defense.
Timing could support outer years. Passing an infrastructure plan would take some effort. A bill as aggressive as the one introduced might pass during the legislative year. After which, implementing the plan, gaining the private side partnership, completing studies for permit approval, etc., requires substantial time. There is no reason to alter growth expectations in 2018 and doubtful a meaningful impact in 2019.
Change of funding. In direct spending, the Federal government is a modest portion of public spending. This classification overlooks federal money that might be transferred to the state to pay for projects. Additionally, the Federal government offers tax advantaged fund raising for state and local projections not included. Private funding works with the public sector, but the size is changing. The evolutions require time. Assuming funding is approved, it adds to later growth rather than immediate.
Environmental and other impact studies. House Speaker Ryan touted a statistic that approvals on public projects take an average of more than four years before a project is started. There are big and small projects, and time variability in reporting is very dispersed around that average. Still, big money chasing big projects can take significant time. One avenue of pursuit by the White House is to shorten government approvals, particularly by the Environmental Protection Agency (EPA).
A Trump victory offered his voters hopes for tax cuts, deregulation, infrastructure spending, a departure from trade agreements and a repeal of Obamacare: some gains, some failures and hopes for year 2
Tax cuts are a big achievement, and vital to Republican campaigns for the 2018 congressional elections. Were taxes a sufficient win to maintain control of Congress? It’s too early to tell. The repeal of Obamacare was a failure despite attempts to spin the repeal of the individual mandate. Trade, deregulation and infrastructure are major agenda items. Of these, deregulations pose the most significant challenge.
Treasury Secretary Mnuchin led the Treasury to recommend significant financial regulatory changes aimed at reducing burdensome and/or inefficient regulations from the Dodd-Frank legislation. Federal Reserve Vice Chair for Supervision is also open to fine tuning significant pieces of the Dodd-Frank regulation. Trump has nominated Jelena McWilliams to chair the FDIC once the current Chairman Martin Gruenberg’s term expires in December 2018. At the SEC, Jay Clayton became Chair in May 2017. These regulatory agencies are prepared to make significant changes. Treasury published key reports covering banks, capital markets, asset managers and non-bank financial institutions.
On infrastructure, we expect hopes are running ahead of reality. Even if Washington passes infrastructure spending bills, it could take some time to be visible in the economy.
Trade is a high-risk platform for Trump. His America First rhetoric is not winning many allies in the world. Tariffs on solar panels and washing machines have Asian trading partners deeply concerned. More recent ominous comments on European trade are confusing for European trading partners. The NAFTA negotiators have completed six out of seven planned discussions, and threats of the US pulling out of NAFTA is a major source of concern in Mexico and Canada.
Trump is pro-business. Many of these efforts are about publicity. If Theodore Roosevelt was famous for a foreign policy that he described as “Speak softly, carry a big stick”, then Trump’s America First seems almost the opposite. Trump voices a frustration on the status quo and is willing to take high-publicity actions and comments to shake up the WTO, trading partners and other multi-country organizations. How far will he go? We watch and remember a back and forth on the Border Adjustment Tax, and how in the end, Trump listened to major business interests.