Markets questions: Tuning into Trump

Here are the big questions for investors and markets this week.

Will investors like what they hear from President Trump?

Mr Trump will address a joint session of Congress on Tuesday (it’s not officially a State of the Union) and with US equities in record territory, investors are very much focused on tax reform and other fiscal measures. Here’s where the Trump trade — based on the expectation of a stronger economy and a significant boost to the bottom line for companies — faces a major test. Lofty equity valuations are relying on a punchy list of big stimulus proposals that generate lots of applause from the Congressional audience.

‘’It could be the most important speech of the first 100 days of the administration,’’ says Marc Chandler, at Brown Brothers Harriman.

Where’s the euro heading?

For all the growing unease from forthcoming elections in the Netherlands and France, one risk barometer has yet to enter the red zone. Implied volatility for the euro over three months recently approached a peak of 11.45 seen in mid-December, but remains adrift of the 13.06 peak recorded in the wake of the UK vote to leave the EU last June. That has helped shore up the euro to some extent after the single currency briefly dropped below $1.05 to the dollar last week.

Also playing an important role, interest rate differentials. The difference between US and German two-year yields has moved well beyond 200 basis points, the widest level since 1999. Much of this has been driven by investors buying short term German paper and pushing the benchmark’s yield towards -1 per cent — representing a hedge against a break-up of the euro. Since mid-December the US two-year note yield has been rather stable and stuck around 1.20 per cent.

This performance reflects the bond market anticipating a path of gradual interest rate tightening from the US Federal Reserve. Hence traders still focusing on June marking the more likely resumption of tighter Fed policy, rather than mid-March. The risk is that a punchy Trump address to Congress spurs selling of US two-year notes and in turn that of the euro.

What’s the status quo trade?

Fast forward to May 8, when France will know the name of the 10th president of the fifth Republic. Were it to be the far-right Marine Le Pen, a reasonable suspicion for how far the euro could drop is below $1, but maybe not too far below.

Nomura’s Bilal Hafeez points out the Front National has only two seats in the legislature and is unlikely to have a majority in parliament, which may lessen the shock of such a victory. In which case the edge of previous valuation extremes may suggest a guide: to be undervalued by a fifth on a purchasing power parity basis, from a tenth now, would suggest a euro worth $0.97.

But what if someone else wins? With inflation and economic growth rising in the eurozone, by the end of the year monetary policy could be heading in the same direction on both sides of the Atlantic, in which case the euro may not stay “cheap”.

More modest ambition in the lucky country?

Australia has not experienced a recession in a quarter of a century, thanks in significant part to selling raw materials to China. But data released last Thursday showed a drop in real capital investment by mining companies of 9 per cent in the quarter, compared to the three months which preceded it.

According to Paul Dales, of Capital Economics, “the first estimate of firms’ capital expenditure plans for the 2017-18 financial year of $80.6bn was also weaker than expected, though it is historically consistent with a final actual expenditure of around $90bn. But even that would be the lowest in 11 years.”