Repositioning under Trump — the big questions

Here are the key questions we are asking at FT Markets ahead of the first full week’s trading after the US election — with the overarching theme being the repositioning across portfolios for president-elect Donald Trump’s transition into power.

Emerging markets — remission, or further pain?

The prospect of a faster-growing US economy is usually good news for emerging markets. When it comes with the risk of trade protectionism and a much stronger US dollar, it’s not so surprising that emerging markets investors are heading for the week with the first two-week outflow from the equities since June. Emerging markets bond funds saw their first outflows in four months. All this came as Mexico’s peso weakened past 21 to the dollar and touched a record low on Friday, when JPMorgan’s emerging markets currency index suffered its worst week in three years.

Given the rampant search for yield this summer that heavily targeted emerging markets assets, there is a very clear risk that the selling intensifies.

“In just two days, half of the last six months’ gains have been given back,’’ says Heinz Rüttimann, analyst for emerging markets at Julius Baer. “We still know relatively little about Trump’s economic agenda and to what extent his rhetoric will translate into action. That is also the main problem in the short term, as uncertainties are increasing for emerging markets.’’

Risks lurking for the great reflation trade

It took just a few hours after Mr Trump’s win for investors to appreciate the prospect of a pro-growth, business and regulation friendly administration that wants to pump prime the economy via tax cuts and massive infrastructure spending. Hence a striking rotation out of bonds and into certain areas of the equity market, financials, healthcare, miners, industrials and materials.

After such a big swing, we are likely to see market bullishness over Trump throttle back amid a great deal of uncertainty about what the president-elect will actually get through Congress in 2017. In a globalised world — with US blue-chips reliant on a sizeable amount of foreign revenues — trade barriers and a much stronger dollar are not ideal. Indeed, the poor performance of US technology shares since the election stands out as a red flag.

“The main downside risks stem from tariff barriers to trade, which would undermine US growth and generate negative spillovers globally,’’ argue analysts at UniCredit, adding: “Any positive growth impact from potential fiscal stimulus would turn into a drag on growth when spending is ramped down again.’’

How far can the dollar rally?

The dollar is on the cusp of a new period of strength. The year began with the dollar index climbing close to the 100 mark in a risk-off climate of China slowdown fears and falling oil, but most of the year saw it bumping along around 95 as the market caught the Federal Reserve’s cautious mood.

The market’s reaction to Mr Trump’s election victory — at least, since his acceptance speech on Wednesday — has propelled the dollar index back to 99, as investors contemplate a policy mix of fiscal stimulus and monetary tightening, bringing higher inflation and gross domestic product growth.

All of this “should keep a December Fed hike in play”, says Morgan Stanley’s Hans Redeker. The risk to this outlook is when the president-elect starts outlining his policies. Investors are waiting to see which of these he prioritises and who he appoints to his cabinet. A pullback in the dollar is just as plausible a scenario as a dollar rise.

What’s powering the pound?

Sterling has enjoyed a boost since the US election, as the intensifying uncertainty elsewhere leaves it with room to rally. Kit Juckes at Société Générale calls sterling as “the least written about and strongest major currency” and points out that some of the support comes from the unclear outlook for the euro, which is leaving the pound looking relatively attractive. Italy’s referendum on constitutional reform and France’s looming elections are particular risk events. “The markets, twice bitten, will shy away from the euro,” predicts Mr Juckes.

How long those conditions hold, and whether the inherent uncertainty of the Brexit process returns to hound the pound, remain moot points. There is retail and producer prices data as well as unemployment and average earnings data published next week that could test the mood.