The Daily Prophet: Congress Can't Walk and Chew Gum at the Same Time

(Bloomberg View) -- If House Speaker Paul Ryan was trying to reassure markets that Congress can simultaneously investigate potential Russian meddling in the U.S. election and possible ties to President Donald Trump’s campaign while continuing to advance the administration’s pro-growth legislative agenda, it didn’t work.

Stocks and the dollar extended their losses and haven assets such as Treasuries and gold soared after the Republican from Wisconsin told reporters that lawmakers are “going to walk and chew gum at the same time.” The turmoil in Washington isn't being confined to just U.S. markets. The S&P 500 Index and the MSCI All-Country World Index of equities both fell the most since September 9, dropping 1.82 percent and 1.16 percent, as banks led the way. Many investors expected the U.S. to be a major engine of growth for the global economy this year, but the latest political developments come at the same time as markets get hit with reports showing weakness in retail sales, housing and inflation.

To be sure, many strategists are advising investors not to get too worked up about the market reaction. While this is was only the second day this year that major U.S. stock indexes fell more than 1 percent, moves of such magnitude are not uncommon. “Financial markets sit in ‘squirming’ mode rather than anything that resembles real concern when it comes to daily D.C. news bulletins,” Jim Vogel, a strategist at FTN Financial, wrote in a research note today. “Just like the first leg of the Trump trade, economic scenarios hinge on a series of future political decisions that traders can speculate about but only with limited conviction.”

“I think our dollar is getting too strong, and partially that’s my fault because people have confidence in me,” Trump told the Wall Street Journal on April 12. The Bloomberg Dollar Spot Index has now fallen for a seventh straight day, effectively wiping out all its gains since the U.S. election on Nov. 8. If there’s less of a chance for tax cuts, regulatory reform and infrastructure spending, then there’s less of a chance that the Federal Reserve will raise interest rates as much as anticipated. Both would diminish the appeal of holding greenbacks. Westpac, the second most-accurate currency forecaster in Bloomberg’s most recent quarterly rankings, is advising clients to sell the dollar against a basket comprising the euro, yen and Canada dollar, according to Bloomberg News’s Netty Ismail. “It seems clear that a political risk premium is being removed from the euro and instead placed on the U.S. dollar,” said Sean Callow, a senior currency strategist at Westpac in Sydney. 

The bond market is starting to sense that the deepest crisis so far in Trump’s presidency will throw the Fed off its path for rate increases this year. The odds that the central bank raises its benchmark rate next month are about 62 percent, based on the current effective fed funds rate and the forward overnight index swap rate, according to Bloomberg News’s Brian Chappatta. That’s down from 80 percent a week ago. The chances they move in September are also on the decline, and the federal funds futures market isn’t pricing in a full hike until November. “If the outlook deteriorates significantly, the (Fed) would likely delay any further tightening steps,” strategists at Goldman Sachs wrote in a research note today. As a reminder, Fed officials project two more rate increases this year. Strategists have forecast a move in June to provide flexibility for policy makers to either raise again in September or December, depending on financial conditions at the time, or introduce a plan to trim the central bank’s holdings of bonds.

Volatility returned in a big way. The CBOE Volatility Index, which is also known as the “fear gauge,” surged the most since June. The VIX has been trading at historically low levels, raising concern that that there was too much complacency in markets. It turns out a lot of investors decided to act on those concerns, and are happy they did. The open interest in VIX calls has surged 79 percent since the April monthly expiration, reaching a record 9.8 million contracts and more than three times the number of puts, according to Bloomberg News’s Cecile Vannucci. The folks at Convergex recently said in a report that there’s really only three periods since 1990 when the VIX held below 10: December 1993, January 1994 and December 2006/January 2007. The firm concluded that a VIX below 10 signals the possibility of a pause in equity returns in the short term.

After suffering mightily during the financial crisis, consumers decided it made sense to trim their high debt loads. That was then. Today, the Federal Reserve Bank of New York said U.S. household debt reached a record high in the first three months of the year, topping the previous peak of 2008. The debt, which includes auto loans and home equity lines of credit, stood at $12.73 trillion at the end of March, up from the post-crisis low of $11.94 trillion in 2013. Though the data isn’t adjusted for inflation or population size, there's a lot of handwringing over auto and student loans. Banks including Fifth Third Bank Corp. have been trimming their loan books and cutting back on riskier credit as delinquent auto loan balances surge, according to Bloomberg News’s Gabrielle Coppola. The share of auto debt more than 90 days overdue rose to 3.82 percent in the first quarter, the highest in four years.

Given all the attention being paid to the U.S. political situation, one can be forgiven for overlooking the problems developing in the U.K. economy. Even as unemployment dropped to its lowest in more than four decades last quarter, U.K. workers saw their real earnings fall for the first time in 2 1/2 years, data from the Office for National Statistics showed on Wednesday. That’s particularly problematic for a nation that has relied on buoyant consumers to keep spending, not least as it enters negotiations to leave the world’s largest trading bloc, according to Bloomberg News’s Scott Hamilton and Lucy Meakin. On Thursday, the government releases the latest on retail sales, which dropped in March by 1.4 percent, the biggest decline in seven years. The economists at Bloomberg Intelligence look for a small bounce in the April data as a result of the later Easter holiday. The Bloomberg British Pound Index has dropped for five straight days, it’s longest slump since March.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is editor of Bloomberg Prophets.

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