Those years of monitoring central bank activity are well beyond us. Blondemoney herself got drawn into that most recent Fed meeting, but from now on the focus is firmly on the politicians. You can’t have a debate over how the Fed will reduce its balance sheet, without keeping an eye on how Trump will populate the Fed with His People, just to get something done. You can’t really expect the Bank of England to have a coherent 2year view on inflation now that the deed is done, Article 50 is signed, and we’re on a rollercoaster whose path no one can predict. Not least of all, the people actually driving the rollercoaster. Soon we will long for the days we could do something as simple as pore over a central bank statement for whether they slipped in the word “appropriate” or “gradual”.
No, now it’s all about how the world of politics actually works. And the reality is that it is messy. This isn’t time for you to roll your eyes about how those blasted politicians need to Get Things Done, and If Only They Worked In Business They’d Know A Thing Or Two. It’s exactly this attitude that leaves the VIX languishing at multi-decade lows. The abject refusal by markets to engage with the politics is why volatility measures are so low. Once investors realise the entire framework of their analysis has to change, there will be a lurch. We are starting to see it, with stocks coming under pressure. Those 114 consecutive days in the S&P without a move bigger than 1% have been broken. There is even a narrative that now suggests stocks should feel a bit wobbly: if they were bought on the premise that Trump would be delivering bold tax reform, that thesis looks more than shaky. There is a dawning realisation that a “clean sweep” for the Republicans doesn’t mean “The Executive branch can get done whatever it wants”. America may have a two party system but each party is a broad church. Two parties doesn’t mean only two opinions. It just means the system was set up such that only two parties would ever be able to survive. The Separation of Powers, where the executive (President) is institutionally prevented from dominating the legislature (Congress) means that you have to corral factions just to get things done. Ironically, the French institutional system creates a much stronger President, as they possess both executive and legislative power: but that’s a story for another day. The story for today is that the so-called “Trump Trades”, such that they ever existed, should be almost dead and buried.
Now, this doesn’t stop the fact that the world economy is doing OK, thank you very much, and that reflation is alive and well. It doesn’t stop the fact that most countries can therefore step back from the unconventional emergency monetary measures they took when deflationary doom was all around. That secular shift in the macroeconomy is done. Higher yields, they are a-comin’.
Hence, the Buy the Dip crowd can merrily fill their boots on assets that prosper in a reflationary environment.
That is until volatility comes back to scare them. This is where we go back to the only nascent appreciation that politics will provide that volatility because it is almost entirely unquantifiable; and it DOES have an impact on the real economy. The UK has been doing quite well since the Brexit vote precisely because of the rebalancing impact of a significantly weaker pound. So the question from here is whether the pound will recover, or take another lurch lower? And that will depend on how the Brexit negotiations proceed. We don’t know, but we do know that we need to factor in these scenarios:
- New governments in France and Germany either support or reject the British position
- The UK can’t marshal its own government and there’s either a new government or its negotiating position collapses
- Negotiations become so heated that both sides are forced to walk away: Theresa May’s ‘No Deal is Better than a Bad Deal’.
This last point is the most significant when people now say the starting gun has been fired on two years before we leave. What if we leave long before that? Why two years? This hasn’t been done before, it could get extended or dropped entirely. Just like a divorce where it plays along amicably until someone realises they can’t bear to let him get away with the family dog, the terms can change in a heartbeat.
What we should be prepared for from this point onwards is that the focus will shift from the UK’s position, to that of the remaining EU 27. Silent up until now, they can let loose and unleash the toughest stance they want. Markets will likely take fright at this, and that “No Deal” scenario will start to loom onto the horizon.
Ladies and gentleman, please take your seats on the political rollercoaster. Sick bags may not be provided.