- Trump leaves today for overseas trip ending with next week’s G7 meeting
- Fed policy is not likely to be affected by this week’s volatility
- Brazilian stock and currency plunge and take down emerging markets and some ag commodities as well
Trump leaves today for overseas trip ending with next week’s G7 meeting — President Trump on Friday leaves for his first overseas trip as president. President Trump will be in Saudi Arabia on Saturday and Sunday, Israel on Monday and Tuesday, Rome on Wednesday, and Brussels on Thursday for a NATO Summit. President Trump will then be in Sicily for the G7 Summit on Friday and Saturday (May 26-27).
The markets will mainly be interested in the G7 Summit. The G7 Summit should go relatively smoothly after Treasury Secretary Mnuchin at the recent G7 meeting of finance ministers and central bankers forged compromise language on trade that can be used in communiques. President Trump is planning on talking with other heads of state at the G7 meeting about the Paris climate agreement. Mr. Trump will then decide whether he will pull the U.S. out the Paris climate agreement, which of course has implications for energy stocks.
Still, President Trump’s foreign trip over the next week is really just a sideshow for the markets, which are focused mainly on whether President Trump and Congressional Republicans will be able to push through corporate tax cuts.
The odds at present do not look favorable for a corporate tax cut this year, even aside from the White House turmoil, because of (1) the difficulty of getting nearly all the Republicans in the House and Senate to agree on single bill, and (2) the fact that tax reform is being delayed until Republicans can get a health bill passed to obtain the $1 trillion of offsets over a decade by repealing Obamacare taxes.
On the tax front, the House Ways and Means Committee next Tuesday (May 23) will hold a hearing on Speaker Ryan’s border adjustment tax (BAT). Speaker Ryan and House Ways and Means Committee Chairman Kevin Brady (R-TX) are still going full speed ahead with their BAT proposal even though the plan was not included in the Trump administration’s recent 1-page tax plan. In addition, Senate Majority Leader McConnell this week said that he did not think there were enough votes in the Senate to approve the BAT plan.
Fed policy is not likely to be affected by this week’s volatility — We do not expect this week’s political turmoil or the new Mueller independent-counsel investigation to have much influence on Fed policy, unless consumer and business confidence start to slip due to Washington political uncertainty. The Fed is chomping at the bit to move ahead with normalizing its monetary policy. In our view, far more than this week’s -2.2% downside correction in stocks would be necessary to knock the Fed off its intended course.
After Wednesday’s plunge in the stock market, the federal funds futures market cut the chances for an FOMC rate hike at its next meeting on June 13-14 to about 70% from 85% earlier in the week. However, those odds then bounced back up to about 80% on Thursday after stocks partially recovered.
The 80% odds for a Fed rate hike on June 13-14 are high enough for the Fed to go ahead with a rate hike without surprising anyone or causing a major sell-off. Indeed, Fed officials over the next three weeks are likely to step up warnings for a rate hike just to make sure a June rate hike is fully discounted. In fact, Cleveland Fed President Loretta Mester (non-voter) on Thursday reiterated her hawkish views that the Fed needs to keep raising interest rates to “remain very vigilant against falling behind” and that the Fed should change its balance sheet reinvestment policy by year-end. She said that the Fed must look beyond temporary fluctuations in the markets.
A rate hike in June would give the Fed plenty of flexibility for the remainder of the year to implement its third rate hike, perhaps in September, and then start trimming its balance sheet either late this year or on January 1. If the Fed can get two rate hikes out of the way and the economy and the markets remain stable, then the Fed will be more comfortable about moving ahead with its balance sheet draw-down by year-end.
Brazilian stock and currency plunge and take down emerging markets and some ag commodities as well — The Brazil Ibovespa (IBOV) stock index on Thursday plunged by -8.80% and the Brazilian real plunged by -7.54% on news that Brazilian President Michel Temer may have been caught on tape approving the payment of hush money. President Temer denied the report and refused to resign. The markets fear that a scandal involving President Temer would jeopardize his reform agenda.
The Ibovespa was ripe for some profit taking in the first place considering the 87% rally seen in the past 16 months. The plunge in the Brazilian stock market also sparked some heavy profit-taking in other emerging market stocks. The MSCI Emerging Markets index (MXEF) on Thursday fell by -2.01%. The MSCI EM index was also ripe for profit-taking, having rallied sharply this year and having just posted a new 2-year high on Tuesday.
The sharp drop in the Brazilian real led to a sharp sell-off in Brazilian agricultural commodities. The drop in the real encourages Brazilian producers to boost their export sales to obtain a better price in terms of dollars versus the real. There were reports of very heavy soybean export sales on Thursday.
Specifically, July soybeans on Thursday fell by -3.18%, July sugar fell by -1.66%, and July coffee fell by -3.53%. The Bloomberg Commodity Agricultural sub-index on Thursday fell sharply by -1.93% and posted a new 1-1/4 year low.
