Donald Trump, Boris Johnson and the markets
Over the past two years, markets on both sides of the Atlantic have had to deal with a considerable degree of economic and political uncertainty. This week’s dramatic political developments in both Washington and London are bound to heighten that uncertainty.
Nancy Pelosi’s decision to initiate impeachment hearings against President Trump will raise the political temperature in Washington and be a major distraction for the Trump administration for the next several months. It will do so in much the same way as the Republican Congress’ impeachment of Bill Clinton was a major distraction for the Clinton administration.
Meanwhile, the UK supreme court’s decision that Prime Minister Boris Johnson’s suspension of parliament was illegal has thrown a spanner in the works for his plans to have the United Kingdom leave Europe by October 31. It has done so by strengthening the European Union’s leverage in the Brexit negotiations and by giving encouragement to parliament to thwart Johnson’s Brexit efforts.
All of this makes it all too likely that U.S. and global financial markets will be in for some rough sledding in the months ahead. But before panicking, market participants might do well to consider how likely it is that those factors will alter the long-run U.S. and UK economic fundamentals.
In his last press conference, Federal Reserve Chairman Jerome Powell identified the factors that were heightening global economic uncertainty and contributing to the global economic slowdown. These factors included an America First trade policy that was causing companies around the world to delay investment decisions. They also included the prospect of the United Kingdom leaving Europe in a disorderly way. That prospect has already put the UK on the cusp of an economic recession.
Over the past year, it is striking how differently the global bond market and the global stock markets have reacted to the heightened degree of economic uncertainty identified by Powell. Judging by the inversion of the U.S. yield curve and by the fact that $17 trillion, or a third of the world’s bond market, now trades with negative interest rates, the bond market is suggesting that both the United States and the world economy are heading for meaningful economic recessions.
Meanwhile, the U.S. stock market continues to trade at historically very elevated valuations, which have only been seen three times in the past one hundred years. This would suggest that the stock market certainly does not buy the bond market’s gloomy economic outlook. Rather, it seems to be thinking that there is every reason to expect that the U.S. economic recovery will continue indefinitely.
If past is prologue, the recent political developments in Washington and London might be spun very differently by the bond and stock markets.
For its part, the bond market might take the view that the Trump impeachment proceedings will only add to Washington political gridlock that will be a further dampener on investor confidence. It also might argue that in a poisoned Washington atmosphere and in the run up to the 2020 elections, the Democratic House of Representatives is unlikely to come to the president’s aid with a budget stimulus package in the event of an economic recession.
Similarly, the bond market might take the gloomy view that Mr. Johnson’s political travails might complicate the prospect of his getting a Brexit deal by the end October. They also might fear the likelihood of early UK elections that could make the UK increasingly ungovernable.
Such gloomy assessments might only confirm the bond market’s view that US and world interest rates had further to fall in an increasingly recessionary and deflationary environment.
For its part, the stock market could very well take a rosier view of the fallout from the recent political developments in Washington and London. It might consider that the Trump impeachment proceedings is unlikely to blow Trump’s economic policies off course. It also might recall that in the case of the earlier Clinton impeachment proceedings, while the stock market did suffer an initial meaningful decline, it soon regained its footing.
Similarly, the stock market might put a positive spin on Boris Johnson’s current political troubles. It might argue that far from increasing the risks of a hard Brexit, Johnson’s political troubles might galvanize him to strike an early Brexit deal with the European Union as the only way out of his current political mess.
Only time will tell whether it will have been the gloomy bond market or the Pollyannaish stock market that was correct in its assessment of current global economic and political risks.
Judging by its better track record in assessing macroeconomic risks, it might not be the wisest of moves to bet against the bond market.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.