Deepening US political controversy stalks markets

US stocks were on track for their worst session for eight months on fears that US President Donald Trump’s ability to push through his pro-growth policies will be sidelined by deepening political controversy.

The Wall Street benchmark fell 1.3 per cent to 2,369 on Wednesday, shedding all its gains for May, with financial stocks the worst hit as the S&P banks index retreated 3.8 per cent. Shares of some of the country’s largest financial institutions, including Morgan Stanley and Bank of America, declined more than 5 per cent.

The Dow Jones Industrial Average was 1.3 per cent weaker while US Treasury yields sank to their lowest levels in a month. Wall Street’s so-called fear gauge, the Vix index of implied volatility, surged by its greatest amount since September.

Reports that Mr Trump had sought to interfere in an FBI investigation is the latest controversy to ensnare the White House, damping global risk appetite and prompting some investors to seek the perceived safety of government bonds, gold and the Japanese yen. Gold climbed the most in a day since the immediate aftermath of the Brexit vote last year.

“Even though there’s a unified government, it’s a lot less unified than it looks,” former Federal Reserve chairman Ben Bernanke said on Wednesday, characterising the Trump trade as “overdone”.

“The markets have unwound a good part of the reflation trade,” he added, referring to the stock market rally fuelled by higher growth and inflation expectations.

The US dollar reversed the near 6 per cent gain it enjoyed after the election, as the euro climbed back above $1.11 for the first time since November. The dollar index, which tracks the greenback against a basket of its peers, dropped 0.5 per cent to 97.58.

Lee Hardman, currency analyst at MUFG, said the move provided “further evidence of the ongoing loss of confidence in the Trump administration’s ability to materially boost US growth”.

The dollar index had climbed to a 14-year high of 103.82 in the aftermath of Mr Trump’s election victory as investors bet that his presidency could boost the world’s biggest economy and encourage the Fed to tighten monetary policy at a faster pace.

Stephen Gallo, European head of FX strategy at Bank of Montreal, pointed out that a stronger euro was the main driving force of the fall in the dollar index, as it “has far and away the biggest weighting” in it.

“I am sceptical about the ability of these Trump headlines to severely weaken the dollar from here on a broad trade-weighted basis, and of their ability to have a meaningful impact on policy at the Federal Reserve.”

Meanwhile, improving corporate earnings helped propel the US stock market to record levels this week with the S&P 500 on Tuesday hitting an intraday high of 2,405.8.

“Up ahead, the true test for US reflation I think is not so much the dollar as the S&P 500, that’s where the over-positioning stands, and likely much of it unhedged,” said Geoffrey Yu, head of the UK investment office at UBS Wealth Management.

“If we see more days where S&P 500 and DXY move in tandem lower, then it would be a strong signal of concern — a total reversal of what we saw in November. We are not there yet, but it’s certainly the relationship to watch.”

US government bonds remain a supposed haven, even when the US government is the source of market angst. The 10-year Treasury yield, which moves opposite to the bond price, is down 11 basis points to 2.22 per cent.

The Japanese yen is among the main currency beneficiaries of the dollar’s woes, strengthening 1.9 per cent to ¥111.03 per dollar.

Mr Bernanke added: “It always puzzled me a little bit — it still does — that markets are blasé about political risk until the last moment.”