Markets prefer to ignore politics

Outlook

US data continues to show resilience and tariffs be damned. Instead of trade war stories, for the first time in weeks the top headline is about other things, like Trump cutting funding to children’s TV.

The firing Powell story has some lasting power. The FT, a day after the event, found it useful to point out that prediction market Polymarket had the odds of the firing as high as 40%, only to backtrack to 20% after Trump’s denial. This misses the point: bettors go with the flow, not with the logic.

First, the Supreme Court told Trump he can’t fire Powell without authentic cause. Powell “lying” to Congress about the restoration of the Fed building can’t be proved and is almost certainly not true, anyway. Yesterday Powell sent a letter to the budget dept refuting charges, including the inconvenient fact that the renovations removed dangerous materials and improved safety, all disclosed continuously to everybody on the list since the project started in 2017. Apparently Powell was tactful not to mention the bad-taste garish refinishing Trump has done to the White House

More importantly, as we wrote yesterday, substituting a Trump toady at the top doesn’t change the Fed rule—it takes a majority of the FOMC to change rates. Trump literally cannot fire another 11 persons.

All this noise points to some factors that are actually important: Trump taking away the Fed’s independence is a big deal that scares investors and traders in stocks, bonds and currencies. We expect the shadow Fed chair to be named in the next few days. This means Trump is playing chicken with all those traders. His ego won’t let him be seen as a loser. He will act.

Our forecast: after some spikes and gyrations, the market will accept the new conditions. Markets prefer to ignore politics. In fact, they go out of their way to ignore politics. The stock market is looking at earnings. The bond market is looking at inflation and GDP. The currency market is looking at bonds and relative yields. Bottom line: Trump wins.

That’s only for a while. Assuming inflation really does spike in Q4 and the labor market shows recessionary distress, the crows will come home to roost. There will be a comeuppance.

Bottom line, the US comes out as a real winner on the creation of varying asset types that the rest of the world wants to buy. In other words, extraordinary privilege is earned and not due only to the US being the issuer of the reserve currency. The authors spend a lot of paper on explaining the real US rates of return compared to others, It’s convincing. However, the trade deficit is indeed a roadblock.

“We find that the present level of the trade deficit is not likely to be

sustainable as it would push the net international investment position (as a ratio

to GDP) beyond levels that have been sustained in any advanced economy.

“Setting the net investment position on a sustainable path requires a

substantial but not unprecedented increase in the US trade balance. If exorbitant

privilege is maintained, the adjustment is some 2 percent of GDP, implying a

depreciation in the real effective exchange rate of some 15 to 20 percent.

“Were the United States to lose its exorbitant privilege, the adjustment rises to over

3 percent of GDP, implying a correspondingly larger depreciation and a faster

accumulation of debt for the same level of the trade balance.

“Continuing the present unsustainable path makes the net international

investment position even more negative and increases the eventual adjustment

needed. It also raises the risk that investors will no longer see US assets as

safe, implying an end (possibly abrupt) to the favorable funding rates implied

by exorbitant privilege. To minimize the risk of financial turbulence and an

uncomfortably rapid adjustment, policymakers should act soon to reduce some

of the underlying imbalances driving the deficit. Most notable is the large US

fiscal deficit. Measures to stimulate domestic spending overseas would help to

offset the contractionary effects of any US fiscal consolidation.

“President Trump’s attempt to eliminate the US trade deficit through tariffs is

not likely to succeed without either causing a recession or driving rates of return

on US foreign liabilities up by more than rates on US assets. The response of

bond and foreign exchange markets to the April 2 tariff announcements suggests

that the latter possibility is in play. Reducing the trade deficit at the cost of

higher interest payments to foreigners would be a pyrrhic victory, as it would not

necessarily make the deficit more sustainable, and it would make any given net

international investment position more costly to maintain.”

Sorry, that’s a bit long but worthy. Trump is correct that the trade deficit should get repaired. But he’s doing it the wrong way. This is not what most economists say. They say the trade deficit is okay as long as capital inflows offset. The Petersen economist say no, the fiscal problem is the biggie in terms of rates of return, which are influenced by the trade deficit. This paper is going to make waves. Too bad they don’t read in the White House.

To return to the rate cut story, yesterday Fed Gov Waller claims his views are not political and nobody has talked to him about replacing Powell. He still rates could be cut as soon as this month because "The economy is still growing, but its momentum has slowed significantly, and the risks to the employment mandate have increased." He is not wrong. And as we wrote yesterday, a July cut could have some positive effects, even if we all know tariffs will hit inflation by Q4 and rate would have to rise again.

Forecast

It’s getting to be time for the currencies to resume their upmove and the dollar to go back to being the outcast. We have chart evidence that this is starting, like MACD reversing and the dollar index topping out as overbought. But nobody can say when, exactly, this is going to materialize. Remember tigers and stripes. If Trump delivers new shocks today and over the weekend, the most likely outcome is the dollar reversal accelerating—unless the bond market takes yields back up again.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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