US markets await next move by Trump, Fed

The last two days of the week have seen US stocks cool down slightly after a relentless, record-breaking run in the previous five days that was due in part to ever-rising anticipation surrounding President Trump’s fiscal stimulus plans. Likewise, the US dollar had been rising in a sharp rebound until the latter half of the week, when continued uncertainty over the Federal Reserve’s path of rate hikes was pushed to the forefront. With a solid earnings season starting to wind down, US equities in the upcoming weeks will be driven even more by Trump’s actions, speeches, and tweets. The dollar will also be affected by developments emanating from the Trump Administration’s economic policies, but even more so by continued speculation over the Fed’s rate hike trajectory.

Much of the rally in US stocks during the past week has been fueled by Trump’s recent comment promising a “phenomenal” tax reform announcement within a few short weeks. This promise further emboldened already-bullish investors who anticipate accelerated company earnings improvements through potentially dramatic corporate tax cuts. On Thursday, Trump held a rather combative press conference attacking the media and intelligence agencies in the midst of questions about his administration’s dealings with Russia. In this press conference, Trump again briefly mentioned the impending unveiling of a new tax reform plan, but spent most of his time on unrelated political offensives. On February 28th, Trump is scheduled to address a joint session of Congress in lieu of a formal State of the Union address (as is common for newly-inaugurated presidents). It is expected that more details of his fiscal stimulus plans should be revealed at that time.

Also this past week, Fed Chair Janet Yellen testified before Congress, providing a statement and testimony that leaned towards the hawkish side. Yellen warned that delaying further rate hike increases would be “unwise,” but also qualified that by acknowledging continued risks and uncertainty in the US economy, notably including the many unknowns surrounding US fiscal policy going forward. Although the US dollar had rallied before and during Yellen’s testimony due to her slightly hawkish tone, the greenback fell sharply in the aftermath as dollar traders began once again to question the Fed’s characteristically ambiguous signals. The indecision continued into Friday as the dollar pared much of those losses. Wednesday of next week brings the minutes from February’s FOMC meeting. More details are likely to emerge from those minutes regarding the factors holding back the Fed.

It is of interest to note that the past association between tighter Fed monetary policy and pressure on equities no longer appears to be substantial. Record-surging stock markets have remained exceptionally complacent and well-supported despite fluctuating expectations surrounding the Fed’s interest rate trajectory. It appears that for the time being, any action or inaction by the Fed can be interpreted as a positive for the highly optimistic equity markets. If the Fed continues to hesitate, sustained accommodative monetary policy should boost stocks even further. And if the Fed raises rates, it would be a strong validation of economic health that should provide the right environment for corporate earnings growth. Therefore, a more relevant catalyst for equity markets going forward continues to be how quickly and how effectively President Trump will be able to push his ambitious tax reform plans through Congress, and what those plans will actually look like if and when he does so.

As for the dollar, its main mover continues to be the Fed’s monetary policy, especially when placed against the backdrop of other major central banks. For now, monetary policy divergence between the tightening Fed and its still-easy or neutral global counterparts remains in stark contrast. This divergence could begin to narrow, but for now, the Fed stands alone in its comparatively hawkish outlook. Over a medium-term horizon, these conditions should at least continue to keep the dollar supported, if not prompt a new leg in the dollar’s bullish trend.