Just when the President Trump-trade was gaining traction on the congressional passage of the Healthcare bill, new uncertainty threatens to derail the driver. Trump's poor-timing firing of FBI head James Comey has unleased fresh unease within the administration and will challenge his enacting critical pro-growth tax reform. Interestingly, the US and China trade deal reached overnight failed to gather much market positive reaction. At this point markets are unconcerned as volatility continues to contract. However, given the overstretched valuation it would not take much to shift investors’ sentiment bearish.
This trigger and with a pause on scheduled risk events (UK parliamentary elections anticipating a landside Conservative victory and Fed 25bp rate hike fully priced in), sustained low volatility will further push investors into yield chasing, powering the already robust carry trade. We see upside for EM growth outlook above 4.5%, so a bit of support from commodity prices will give EM another strong bound. For today, US economic data will further support USD buying. Recent US data has been surprisingly solid followed by hawkish Fed comments and has pushed US yields higher. Markets expect headline CPI to increase by 0.2% m/m in April, which converts into annual inflation of 2.3%. Excluding energy and food prices, we think core CPI inflation will ease back to 0.2% m/m and annual 2.0% (flowing a fall for -0.1% in March).
We suspect that the reversal of inflation decline will keep pressure on the Fed to hike two or possibly three times in 2017. Given this scenario, we believe the market is still underpriced and should give short-end rates a boost. Higher front-end yield also equates in our mind to earlier discussions on strategies for reducing the Fed balance sheet (indirect tightening).
Retails sales will also be released, after slowing in 1Q February and the March headline fell 0.2% m/m consecutively, driven by weak sales in the auto sector. However, rebound in ISM non-manufacturing indicates that we should see a bounce. We anticipate that April headline retail sales will increase 0.6%. In addition, the markets will get business inventories and University of Michigan consumer sentiment.
By Peter Rosenstreich