It has been a total and utter rollercoaster ride on equity markets over the past couple of weeks.
After a year of very solid gains and very little volatility, and an incredibly strong January, all hell has broken loose.
Market fear and volatility have been driven by strong economic data out of the US, in particular, and nervousness about the potential for inflation to raise its head after a long period of dormancy.
In addition, the way computer-based trading now dominates market trading, volatility tends to be exacerbated in an alarming fashion.
Unfortunately, it appears likely that we are entering into a period of much nervousness and volatility, which perhaps should not come as a surprise after a nine-year bull market which has resulted in pretty high valuations, particularly in the US market.
Donald Trump has taken a lot of the credit for the strong economic recovery and the surging equity markets since his election, but there is a strong sense that his policies are storing up trouble in the longer-run and are now instrumental in driving changed equity market sentiment.
At the moment, he is implementing a relatively large fiscal stimulus package in an economy with a reported unemployment rate of 4.1% and where economic activity is proceeding at a pretty brisk pace. The theory of fiscal policy is that it should ideally be counter-cyclical.
In other words, when an economy is growing strongly, fiscal policy should be tightened, and when an economy is growing weakly, fiscal policy should be relaxed. Just as we did here in Ireland after 2000, Trump is now doing exactly the same thing at the moment.
During the week, an economics professor in Michigan tweeted that “a future economics student is going to look back at 2018 and ask me why the US government embarked on a massive fiscal stimulus when unemployment was 4.1% — I have no idea what to tell her”. That pretty much sums it up.
The net result of this fiscal stimulus package is that bond yields should rise on the back of pro-cyclical fiscal policy and on the back of the longer-term implications for the US public finances of what Trump is doing.
If one superimposes on this scenario the ongoing reversal of Quantitative Easing (QE), then it is hard to see how bond yields will not rise further, thereby creating more uncertainty for equity markets.
President Trump should realise that there is such a thing as cause and effect.
The other manifestation of Trump’s fiscal policy will be seen through its potential impact on the trade deficit.
He was elected on the back of some very strong messages about his intentions to reduce imports, preserve US jobs, and reduce the trade deficit.
This is not working according to plan.
In 2017, the US trade deficit widened by 12.1% to reach $566bn, its highest level since 2008.
Exports expanded by an impressive 5.4%, but imports surged to $2.3tn (€1.88tn), which is the second highest level on record.
Controversially, from the perspective of Trump’s vigorous rhetoric, the deficit with China reached a record level, and the deficit with Mexico reached its second highest level on record.
Among other things, this reflects the strength of economic activity in the US, which is leading to increased demand for imports.
The problem, of course, is that the fiscal stimulus plan will just serve to further fuel demand for imports and widen the deficit even further.
This will put increased pressure on Trump to push his trade protectionist agenda, which would not be good news.
With a widening trade deficit and a negative longer-term outlook for the already imbalanced US public finances, the dollar logically should weaken further over the coming months.
The risks appear to be going in one direction at the moment.
Given how important US visitors to Ireland have become in the face of reduced numbers from the UK, the weaker dollar does pose a threat to the record-breaking tourism sector.
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