Politics is Front and Center
Again, politics is front and center in the minds of investors: The tide is changing inside the White House; Congress is as gridlocked as ever with Republicans failing to act on trademark legislation; and, on the back of the horrific attacks in Syria, geopolitical tensions are bubbling to the surface. Nikolaj Schmidt, Chief International Economist at T. Rowe Price is giving an overview.
Since the inauguration, two wings inside the White House have fought for the president’s attention: the far right wing led by the president’s Chief Strategist Stephen Bannon and the left-leaning group led by the his son-in-law, Jared Kushner, and former Goldman Sachs President and Chief Operating Officer Gary Cohn. The latter are both associated with the Democratic Party. The sidelining of the far right wing, the "nationalists", was most clearly exemplified by the removal of Bannon from the National Security Council. The removal of him did not go down well, and the media has been rife with speculation of his impending departure from the White House. Why has the president sidelined the right wing? For one, the president seems to put family first but, probably more important, Bannon and the right wing have been closely associated with a number of legislative failures: the immigration ban, which is stuck in the U.S. court system for a second time, and the failure to repeal and replace the Affordable Care Act, also known as Obamacare.
What are the implications of the turn to the left? Given Democrats’ lack of willingness to work with the president, the Republican leadership depends on near-unanimous support to push their legislative agenda through either chamber of Congress. The turn towards the left is viewed with skepticism by the House Freedom Caucus—a caucus of 30 lawmakers who have already made their presence felt when they refused to support the repeal and replacement of Obamacare. This was trademark legislation of the Republican Party and, under President Obama, the House repeatedly approved legislation to end it. The growing distrust between the Freedom Caucus and the president underscores that President Trump’s ability to deliver on tax reform will be anything but smooth sailing. Further, the distrust has been aggravated by personal attacks by the president on individual members of the Freedom Caucus and by comments from the White House that he will work with Democrats, if required, to pass the tax reform/legislation.
The bottom line is that a turn toward more moderate policymaking is a positive from an international perspective, but it complicates the president’s domestic legislative agenda. We continue to expect some fiscal stimulus in the form of tax cuts, but we continue to believe that the market is a bit too optimistic with respect to both the time line and the size of the coming fiscal stimulus. Nikolaj Schmidt, Chief International Economist at T. Rowe Price, keeps a close eye on developments at the White House given that everything seems to be in a state of flux.
President Trump, China, and the world
President Trump’s much-anticipated meeting with Chinese President Xi Jinping coincided with the decision to launch a strike against President Bashar al-Assad of Syria. The strike in Syria was delivered in response to President Assad’s use of chemical weapons in the civil war in Syria, a violation of the Chemical Weapons Convention. Unlike previous administrations, President Trump made the decision to strike unilaterally: There were no prior votes in the Senate, nor was there any prior discussion with the UN. The strike against Syria was designed to minimize human casualties while delivering meaningful damage to material. We think that the U.S. strike is President Trump’s first meaningful win: The strike has been broadly supported by both the international community and by domestic local lawmakers from both parties.
However, by acting decisively to an incident that did not directly involve American interests, President Trump has challenged the notion that his ascendency marks the end of the Pax Americana. The strike in Syria was met with serious protests by Russia and Iran, countries aligned with President Assad. Will this lead to further escalation between the U.S. and Russia? Most likely, Russia will continue to voice its discontent about unilateral action, but Nikolaj Schmidt does not expect the crisis to escalate beyond just hard talk. As a nod in this direction, a spokesman for President Vladmir Putin informed the Associated Press already on April 6 that Russia’s support for President Assad is not unlimited. Additionally, since the strike in Syria, Secretary of State Rex Tillerson has on numerous occasions indicated that the priority of the U.S. is to defeat ISIS, an agenda that runs somewhat orthogonal to a regime change in Syria. Lastly, despite hard talk from the UK, the G7 did not achieve consensus on the implementation of additional sanctions against Russia or Syria.
Was the strike in Syria an exercise in Pax Americana or an exercise in America First? At least a part of the motivation behind the strike was to send a strong signal that the North Korean nuclear weapons program (another violation of UN conventions) must be brought to a halt before North Korea obtains the capacity to launch a nuclear strike against the United States. Given trade links between China and North Korea, the U.S. administration sees China as instrumental in achieving this objective. Notably, despite casting a veto vote earlier in the year against further sanctions on the Assad regime, China did not condemn the strike in Syria. Local Chinese media also characterized the meeting as being successful. Meanwhile, the U.S. has moved the USS Vinston Strike Group toward North Korea, China has stationed 150,000 troops on the border of North Korea, and China and South Korea have released a joint statement that further missile tests by North Korea would trigger measures in line with the UN Security Council Resolutions. Altogether, the meeting between President Trump and President Xi appears to have crystalized an agreement to ratchet up pressure for the regime in North Korea to abandon its nuclear weapons program.
How did the rest of the meeting go? On the economics side, there was not much news—and in financial markets, no news is good news. The heads of state agreed to set up a task force to analyze how trade between the two countries can be rebalanced. As highlighted by our internal China expert, Sovereign Analyst Chris Kushlis, in essence this can be seen as a renewed commitment to the Strategic and Economic Dialogue (albeit with slightly different parameters).
What does this mean for markets?
On the U.S. policy agenda, from an international perspective, the turn toward the more moderate "globalist" advisors is positive, although this comes at the cost of greater challenges to the domestic agenda of fiscal expansion. From an asset market perspective, the latter is probably not too worrying as a less supportive fiscal agenda will remove some of the pressure on the Federal Reserve to hike interest rates. Tensions on the Korean peninsula and rising frictions between the U.S. and Russia do, however, increase uncertainty and will likely provide a headwind for risk assets. As noted though, we do expect some of the tensions between Russia and the U.S. to de-escalate over the coming weeks. With respect to the pressure on the Korean peninsula, the agreement between the U.S., China, and South Korea to increase diplomatic pressure on North Korea is positive, although the prospects of an armed conflict will continue to weigh on risk markets.
On balance, T. Rowe Price sees the recent developments as supportive for bond markets in the developed world and as supportive for developed market currencies against the U.S. dollar. In the emerging world the picture is more complex, but, on balance, global developments, the combination of growth and inflation, and improving politics probably still favor exposure to emerging market fixed income assets in regions with low proximity to Korea. Overall, global developments appear to challenge the performance of assets with a high exposure to global growth, and they see it prudent to hedge against a prolonged and intensified conflict on the Korean peninsula.