Buy The Election, Sell The Inauguration

17 January 2017

Quarterly Strategic Allocator

Buy The Election, Sell The Inauguration

Highlights

¨   Since the unexpected happened in 2016 against global consensus – the Brexit and the election of Donald Trump – we continue to advocate that political risk will shape the investment landscape into 2017 as one of the main factors for financial markets, even before fundamentals. While the GBP depreciated by c.20% since the Brexit on serious concerns over the future of the UK, the USD rose by c.5.5% since Donald Trump was elected President last November fuelled only by speculation that his policies will give a strong boost to growth and inflation. However, market participants only focused on the best of his campaign promises, e.g. tax cuts and infrastructure spending, and have yet to fully factor in that he could implement the worst of his proposals such as engaging China in a trade war, withdraw from major treaties, or build a wall around the Mexican border. That said, we still believe that Mr. Trump will remain constrained by Congress and that he will be fiercely opposed by Democrats and potentially by some Republicans who parted during the campaign. As such, Trump’s decisions could have softer effects than consensus expectations, especially as too much of Trumpflation has already been priced in. Finally, on the economic front, although growth is expected to pick up, it remains at low levels while inflation against the backdrop of commodity recovery is likely to stay elevated.

¨   While global Central Banks were under the spotlight in 2016, their influence could be more muted in 1Q17.There might be little to expect yet from the ECB and the BoJ. With high political risk in France, Germany and the Netherlands with upcoming elections, in order not to alter a tepid economic recovery, the ECB will maintain its QE as it announced in December; further economic development, regarding growth and employment will be scrutinized to define the future of its policy. In Japan, albeit rising, headline and core inflation forecasts remain far from the 2% target, keeping the BoJ committed to its QQE with yield curve control. However this may not be the case for the Fed; we will eye any rhetoric change as too many uncertainties remain, paring down expectations of the current 3 rate hikes. 

¨   After the inauguration of Donald Trump on January 20^th, the Trumpflation trade can temporarily revive (positive USD / EM negative) if further details on the positive policies are given, before fading away around the middle of the year as: (i) Trump is more centrist than extreme; or (ii) he is faltering on his best policies; or (iii) an implementation lag. On the other side of the Atlantic, after the US Inauguration, the European political cycle will start to kick in with the Dutch election on March 15^th, French presidential and legislative elections spread from mid-April until mid-June and the German federal elections on October 17^th. This has the potential to exert bearish pressure on the Euro, expected to test parity over the first part of the year. Ongoing Brexit negotiations (with an informal deadline to trigger Article 50 by March 31^st) could also cast clouds over Britain hence the EU. Geopolitical risks, terrorist threats, and influence rebalancing across Asia could further support risk-off periods.

¨   At this juncture, too many uncertainties and risks persist, which could boost the allure of safer assets such as USTs, JPY and Gold over the course of 2017. Yet for 1Q17, the charting approach confirms that the Trumpflation trade could regain momentum during the first weeks of Trump’s presidency with the broad USD appreciating further and against the backdrop of a softer EUR. However, since too much of this trade and rate hike expectation have also already been priced in, coupled with an overvalued USD (c.12-14%), both USD and UST yields could soften. In Asia, portfolio flows will remain an important catalyst for currency movements, expected to remain pressurized as long as the USD strength persists.