Selling of risky asset shifted into high gear after a weak US session. The lack of real drivers has allowed noise around US politics to derail fundamentals optimism. The initial news of allegations that Trump leaked classified then demand x-FBI Director Comey pledge loyalty generated scant market impact. Yet suddenly markets have created a theme to trade-off. Given the fact that there have been no structural shifts we suspect that current bout of risk aversion to be short lived. Our defining theory for 2017 has been to avoid hype and focus on fundamentals, which we will despite lots of red on the board.
US long end yields fell, flattening the curve slightly, as investors liquidated risk assets. The narrowing of US-JP yield differential gave JPY a broad based boost providing further effect of a global concern. Despite the choppy rally in volatility (which was going to happen regardless due to ultra-low levels) the economic data continue to support risk taking. EU data indicated that growth momentum remains solid. US industrial production surged in April to its fast pace since March 2014 (house building data disappointed slight but from an elevated level). Only China industrial output came in softer than expected, yet since controlled policy tightening was the primary culprit, deeper deterioration is unlikely.
While the Trump reflation’s story has taken a hit on lower expectation for his pro-growth agenda, we remain buyer of EM FX in dips as the core themes (higher growth, low interest rates / vol, and fading protectionism) should support risk taking. USD has been on the front of much selling as weaker CPI and strong EU data has shifted the balance of tighten expectations to Euro. The low USD position suggests that in our view markets are underpricing the Fed policy path. Improvement in economic data from now till 14th June will asymmetrical favor USD.
By Peter Rosenstreich
