As Donald Trump visits this region, in his first foreign trip since becoming the US president, the markets may have some time to digest the volatility of the past week and to assess if it is justified and likely to continue.
The key issues going forwarded will be how shielded economies can remain from the noise emanating from the White House, and whether policy decisions will become affected by it.
Last week saw an abrupt reversal in market sentiment after a period of exceptionally low volatility and an extended period of minimal market corrections.
The week ended, however, with nerves calmer than they were in the middle of it, with the VIX volatility index off its weekly highs after the US justice department’s appointment of Robert Mueller as special counsel provided some reassurance that the situation in Washington might no longer be spiralling out of control.
Better than expected jobs data and regional manufacturing data also helped to stabilise risk sentiment. However, the dollar remained soft recording its worst week in over a year, and it still appears vulnerable as foreign investors seem much less sure about the direction that the United States is taking.
The dollar was, in fact, the first market to signal concerns about the latest turn of events in Washington with a reversal in the dollar-yen rate after earlier gains portending a switch in risk appetite. Talk of impeachment proceedings against Mr Trump caught the market by surprise and, although the prospect of this might be low for now, with the bar for impeachment being a relatively high one (essentially it needs a two-thirds majority in congress), the questions about the impact of recent events remain. How much will the controversies in Washington impact consumer and business sentiment and how will this affect the economy as a whole?
How much will the reform agenda of Mr Trump and the Republican Party be affected, including healthcare reform, tax reform and deregulation?
And will the drama playing out in Washington have any impact on monetary policy, disrupting what was previously assumed to be a straightforward glide towards two more interest rate hikes this year?
The starting point to all this is a mixed one as although readings of consumer and business confidence have been firm of late, the US economy started the year, as it often does, in relatively weak shape overall, growing by just 0.7 per cent in the first quarter. Much of the optimism about the rest of the year was predicated on Mr Trump being able to enact a number of key reforms, chiefly by cutting taxes and increasing spending on infrastructure. Without these it is unlikely that the US economy will be able to grow by the 3 per cent to 4 per cent rate the Trump team has been aiming for, above the 2 per cent it has been averaging for the last few years.
The US treasury secretary Steve Mnuchin last week reiterated this target but it is becoming clear that tax reforms are not yet at a serious stage of implementation.
If there is less chance of such reforms being enacted, as the White House becomes more defensive and congress gridlocked, then reduced growth prospects might also undermine the need for further monetary policy tightening. As things stand the markets still expect a rate hike to occur in June but expectations about this wavered last week and any further turmoil could cause the Federal Reserve to think twice, especially as inflation risks do not appear to be too pressing. And even if the Fed does raise interest rates next month, the certainty of another one would probably be in doubt.
The bad news for markets is that the process of investigations is likely to take quite a long time, as the political controversies surrounding the White House and its reactions to them are not going to suddenly go away. The uncertainty may, in fact, continue all the way to the mid-term congressional elections next year, although at the moment it seems as if the pace of recent events is already reaching the point of becoming unsustainable.
A collective pause helped along by the distraction of an overseas trip might be wished for by those still believing in the “reflation trade”. But from another perspective, whatever the eventual outcome the quicker it happens the better the market response is likely to be.
Tim Fox is the chief economist and head of research at Emirates NBD.
business@thenational.ae
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