Pivotal month for markets as Article 50 is likely to be triggered and Trump promises “phenomenal” tax cuts
March looks set to be a pivotal month for markets. Theresa May is likely to finally trigger Article 50 and voters go to the polls in Holland in the first of a series of significant elections in the Eurozone. There are also key central bank meetings at the European Central Bank (ECB) and Federal Reserve (Fed) that could set out the trajectory of monetary policy. However, the dominant theme for markets remains the Donald Trump reflation trade.
Whilst Trump’s new administration continue to talk the talk we have yet to see any real details on the much anticipated fiscal plans. Trump has whetted the market’s appetite by stating (or invariably tweeting) about ‘phenomenal’ tax cuts in the weeks to come and he launched a review into easing the regulatory burden on banks. Equity markets are keeping the faith that Trump can deliver, but the message from the bond market is less optimistic. US treasury yields (which move inversely with prices) have again moved lower on signs that any positive impact on the US economy could be delayed until next year. This policy implementation risk, that tax cuts and infrastructure spending do not come through quick enough, is the key factor that could disrupt the momentum behind the Trump reflation trade and cause equity markets to pull back.
The uncertain fiscal outlook in the US is also making the intentions of the Fed harder to read. Market interest rate expectations have risen since Trump’s election victory and a more hawkish consensus amongst Fed members has left the door open for another rate increase as early as this month. The Fed are forecasting three rate hikes this year, still above market expectations. Although the labour market appears to be close to full employment, we still believe the Fed will want to see more clarity on Trump’s fiscal plans before pressing ahead too aggressively this year. Whilst markets currently appear relatively relaxed about the prospect of further rate increases, the risk remains that any delay in fiscal measures, combined with tighter financial conditions (higher rates and a stronger dollar), causes the US economy to lose momentum going into the second quarter.
The Bank of England notably revised up its 2017 GDP growth forecast in February’s Inflation Report to 2% (up from 1.4% in November), well above the consensus of 1.2%. After a (possibly overly) pessimistic view of the economy the lead up to the referendum, we feel the MPC have now placed themselves under unnecessary pressure with an overly optimistic view of the UK’s growth prospects. After a solid finish to 2016 we are seeing early signs of the economy losing momentum. Purchasing Managers’ Indices, more forward looking sentiment indicators, are beginning to roll over and there is early evidence that the squeeze on disposable incomes is beginning to take hold on the UK consumer. Indeed, the MPC now sees more slack in the labour market than previously estimated, suggesting wage growth will remain subdued whilst inflation continues to rise. With Article 50 likely to be triggered in this month and headwinds facing the UK consumer, the hard yards are clearly ahead for the UK economy. As a result, we are beginning to see analyst earnings forecasts for more domestically-focused UK companies rolling over.
The Eurozone economy continues to show signs of a cyclical upswing and an improvement in analyst forecasts. Like elsewhere, inflationary pressures appear to be finally building and headline CPI is finally approaching the ECB’s 2% target. With the ECB due to meet this month, questions have been asked about whether the pick-up in inflation expectations will be enough to cut asset purchases further and begin the process of slowly withdrawing monetary stimulus. We don’t believe this will be the case in the nearterm, but markets will be focused on Mario Draghi’s tone following the meeting and hints that further tapering is on the table.
The more pressing hurdle for markets to negotiate remains politics within the Eurozone with a series of key elections on the horizon. The French yield spread (difference) over German bunds, the market’s key barometer of political concern in France, fluctuated substantially in February. Concern has eased in recent weeks with polls still suggesting that the chances of the anti-euro Marine Le Pen eventually winning remain slim. We agree with this view but markets will remain sensitive to swings in the polling data over the coming months and we cannot rule out a Le Pen victory altogether given the political shocks over the last year.