I said Father Washington, you're all mixed up
Collecting sinners in an old tin cup
Well, spare a listen for a restless fool
There's something missing when I read your rules
A Soapbox Opera
Doris has passed, other storms may be brewing, but is spring approaching? Metaphorically, this is what investors have been wondering as the reflation trade gathered steam. The economic outlook undoubtedly looks bright with macro data that is generally (and sometimes surprisingly) strong in the major regions, including the UK. Inflation is rising, but not yet to worrying levels. Global earnings growth has turned positive for the first time in a while. And consumer and business confidence have been rising to multi-year highs. So what about those storms?
As has been the case for much of the past decade or so, these involve political events. First, on March 15 Dutch voters are going to elect a new government. Although polls are fluctuating, the populist Freedom Party (PVV), headed by Geert Wilders, has a high probability of becoming the largest party in the Netherlands. Nevertheless, the fact that almost all other parties refuse to enter into a coalition with them will likely prevent the PVV from governing. On the other hand, trying to establish a majority government between other, but smaller, parties could become troublesome for this small but increasingly Eurosceptic country.
This is followed, towards the end of April, by French voters in their Presidential election. Again, polls are fluctuating but they suggest that the populist Front National, headed by Marine Le Pen, will win the first round. So far campaigns of a number of candidates, including Le Pen, have been damaged by controversy. Also, due to the binary nature of the second round, she is not expected to prevail and thus unlikely to become president. Still, markets have become more concerned recently, reflected in the growing spread between French and German bond yields:
This concern was raised, for example, by the risk of a coalition between the left-wing parties. Such a move would not only leave voters in the final round with a choice between two Eurosceptic candidates but would also improve Le Pen’s chances of winning. The reason for investors’ nervousness is the feared impact of a Le Pen win. Her plans, including holding a referendum on EU membership, would pose serious questions about the future of the EU and the euro, as well as possibly trigger French sovereign debt restructuring.
As far as Europe is concerned, there are of course always other issues to worry about, like Italy, Greece, or Brexit. More importantly, however, is the transition by the new US administration, headed by president Trump who will address a joint session of Congress this week. Although it is early days, it seems hard to think of his first 100 days in office as being a Honeymoon. In fact, I think there is a real risk of a dysfunctional administration, not only because of its own (controversial) members, including an erratic president but also because of sustained inaction, pushback or even obstruction by other interest groups. Apart from the intelligence community and the media, these include federal (regulatory) agencies like the IRS and the Environmental Protection Agency. This would not only jeopardize the ambitious agenda of fiscal, tax, trade, and regulatory (reform) policies that got investors excited in the first place. It would also frustrate a populace that has lost patience.
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When Supertramp released their album on which Soapbox Opera featured, called “Crisis? What Crisis?” Gerald Ford was president of the USA. The US dollar stood at 2 against sterling, US debt to GDP was slightly above 30%, and gold was quoted at $150. But inflation was running hot, forcing the Fed, headed by Paul Volcker to aggressively raise rates.
Although currently, inflation remains low, things clearly have heated up in a different way, this time with people aggressively raising their voices. The populist movements in general and recent election results, in particular, have revealed a divisiveness that will not allow the status quo to remain. Based, for example, on the participation of previously apathetic voters, more than anything they show a belief in change. Economic reflation on its own, basically subscribing to the good old Bill Clinton slogan “It’s the economy, stupid”, is unlikely to do the trick. If only because it is based on the same fiscal and monetary expansion dogmas that pushed up the US debt/GDP ratio to the current 105% and did not benefit those who forced the political shifts.
A number of economists and other experts have argued that voters have not acted rationally. Some even want to reverse decisions, for example on Brexit. They miss the point. Supertramp’s intro to their song remains appropriate in that regard: “I hear only what I want to hear; But, I have to believe in something; Have to believe just one thing”. Perhaps Trump recognized the truth in Obama’s slogan?