Markets struggle as Trump still a red flag for risk

After looking like the markets may take a respite from the selling pressure triggered by a US political crisis first thing this morning, the sell-off in risky assets is now back with gusto. European indices are down more than 1% so far today, while the gold price has reversed course and is $10 higher at $1,264 at the time of writing.

Has the political genie escaped from the bottle?

We will be watching the futures markets to see if sentiment towards US markets change, but after Wednesday’s steep sell off, a bit of profit-taking is to be expected. However, this does not mean that the political risks are put to bed, if this crisis continues to escalate then we would expect a further sharp reaction in the markets. Ben Bernanke said on Wednesday that he was amazed that investors had become so blasé about political risk, until it was staring them in the face. If the political genie has escaped from the bottle, then it could be an edgy summer for investors as they remain cautious about the political outlook for the US.

We continue to think that the bar to impeachment is high, after all, there are some questionable aspects to Comey’s character (remember the reopening of the Hillary emailgate a few weeks before last year’s election?), and the Republican Congress may be wary of starting proceedings that could impeach their own President. However, if it does come to this then we would expect to see both the dollar and US stocks slide sharply and in tandem, which would be a clear sign that the political situation in the US had taken a severe turn for the worse.

Do stocks really reflect the level of risk in markets right now?

Right now, the market has to weigh up whether the slide in stocks, the S&P 500 is down 40 points from this week’s record high, is enough of a reflection of the political risk that has emerged in Washington. 40 points doesn’t seem like much, however, markets move on news, and if we don’t get any fresh developments this week on ‘Trumpgate’ then we could see markets stabilise and volatility start to retreat. This is already being reflected in the gold price today, which has fallen at the open on Thursday after a $20 boost on Wednesday. However, even if stocks do make a recovery on Thursday, the days of record highs for US stock indices and a rock bottom low for volatility could be a thing of the past.

Stocks vs. the USD

If Congress gets side-tracked by this scandal then we could see a prolonged period of stalemate in Congress. Usually political stalemate can benefit financial markets as it can create certainty that nothing will change, but the markets rally since November has been based on Trump’s economic policies getting to see the light of day. If Trump becomes a lame duck President this early on in his tenure, then the prospect of his legislative agenda being made into reality is slim. If this happens then the S&P 500 could be more at risk than the dollar. The dollar has slid since January, whereas the S&P 500 has continued to break fresh record territory. Thus, if the political crisis reaches a plateau, we could see the dollar/ S&P 500 relationship breakdown: the dollar could rally on inflows into US Treasuries and the prospect of Fed rate hikes, even if US stocks remain under pressure.

Looking ahead, UK retail sales and US Philly Fed are worth a look, strong sales could boost the pound later today and finally get GBP/USD above the 1.30 level. 

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