Trump trade set to fixate investors in busy April

Here are the main questions facing markets as a new trading week and the start of the second quarter beckons.

What are the likely drivers?
A host of market-moving events confront investors as the calendar flips over to April. These include France’s presidential elections and the opening salvos of the UK’s divorce from the EU.

But there is also the prospect of a sustained recovery in global activity, the risk of central bank policy surprises and the question of whether companies deliver better earnings growth.

Above all investors will remain fixated on the Trump trade and whether the administration can work with Congress and deliver on promises of tax cuts and fiscal stimulus that have bolstered US and global equities since November.

Eric Stein, portfolio manager at Eaton Vance Investment Managers, says prospects for the Trump trade will be an “important macro driver of markets” in the coming quarter.

Further gains for equities on evidence of additional strength in the global economy and any hints of US stimulus proposals bearing fruit would only raise the pressure for central banks, starting with the US Federal Reserve.

“Equity market valuations are stretched and are beginning to create challenges for the Fed and other central banks,” says Jack Ablin of BMO Wealth Management. “Policymakers would like to maintain negative real rates, but market froth and the potential for bubbles could limit that strategy. Expect hawkish rhetoric.”

One troubling aspect of the bullish performance of risk assets is the fact that global credit flows — US, Europe and China — have slumped in recent months.

BCA Research highlights this in the accompanying chart and warns: “Rather than accelerate in the coming months, global growth may level off or even decelerate. Until the conflict between soaring animal spirits and weakening credit impulses is resolved, we will lean against any rise in high-quality bond yields and equity prices.”

What do Fed officials think about the balance sheet?
The minutes of the March meeting, to be released on Wednesday, will provide bond traders with an opportunity to detect the tone of the internal debate about the central bank’s vast holdings of mortgage and Treasury debt.

In its statement last month the Fed reiterated that it anticipated holding its $4.5tn balance sheet unchanged until normalisation of official rates was “well under way”.

The general view among bond traders and analysts is that the central bank will look to reduce reinvesting maturing securities during the fourth quarter. By then at least one and possibly two policy tightenings will have been implemented, allowing the Fed to taper or halt reinvestment flows.

William Dudley, president of the New York Fed said in an interview with Bloomberg last week that he does not expect the gradual normalisation of the central bank’s balance sheet to cause ructions in the financial markets since investors are already expecting the move.

One factor guiding policy towards the balance sheet will probably be the relationship between short-term and long-term interest rates, the yield curve. A flatter curve, where the relationship narrows, would probably provide the Fed will more latitude to run down the balance sheet. But a steepening curve — perhaps driven by concerns that inflation is picking up speed or there is a lack of buyers of long-term Treasuries — might well contain any shrinking of the balance sheet this year.

What about the US-China summit?

Donald Trump’s two-day meeting in the coming week with his Chinese counterpart, Xi Jinping, at Mar-a-Lago has already been billed as “very difficult” by the US president — an inauspicious prelude to what is meant to be a getting-to-know-you encounter between the world’s two most powerful leaders.

The US could “no longer have massive trade deficits and job losses”, Mr Trump said in a tweet.

China’s $300bn component in the US annual trade deficit of $500bn will head the agenda. Mr Xi has instructed his ministers to defend China’s position.

Tied into this issue is currency manipulation. The US Treasury department’s update on this thorny topic is due this month, although the extent to which China has been propping up the value of the renminbi makes it a difficult charge to justify.

Markets are phlegmatic about Mr Trump’s protectionist threats. Having turned sceptical about the promises that generated Trump trades, they need to see evidence of US trade relations being reset before deciding how much protectionism matters.

But nothing matters in trade as much as the US-China axis, so the Florida summit and all its trappings — body language, photo opportunities, handshakes — will be sifted for meaning.