The Trump trade is back on but watch the Vix

Markets have continued Friday’s upbeat theme, futures are pointing to a strong open in the US, and the dollar is stronger across the board in early trading. In contrast, the atmosphere across the Atlantic is notably more restrained. European indices did not share the same buzz as their US counterparts on Friday; even while US indices reached fresh record highs, the Eurostoxx index fell back. Political fears, mixed with concerns about Greece’s ability to pay back large debts in July, are starting to bite, and there could be further declines for European stocks, and some bond markets in the coming weeks and months.

The Vix suggests that everything is fine and dandy with Trump

While volatility is rising in Europe, as measured by rising European bond spreads, it is worth noting that the Vix, a measure of the S&P 500’s volatility, closed below 11 at the end of last week, the third consecutive week it has done so. This is significant; as it is the first time it has done this since 2006. This is another sign that, for now, the Trump trade is still on. It also suggests that even with the controversy Trump has caused since he took office, financial markets are still willing to give him the benefit of the doubt. But remember, the Vix doesn’t stay low forever, and at these low levels it looks ripe to burst higher at any time, consigning the Trump rally to history.

Are markets getting less sensitive to Trump’s tweets?

Trump is, without doubt, a key theme of 2017, however, in the past week I have noticed a few changes in the way he is impacting financial markets. Firstly, the tweeter-in-chief might be losing some of his potency. The markets are starting to get used to his Twitter outbursts, and even after retailer Nordstrom was singled out for his ire last week, its shares actually rose after it received the ‘Trump treatment’. Secondly, the markets are now focused on 28^th February, when Trump will give his first State of the Union address to Congress and is expected to lay out his taxation and infrastructure plans. Big things are expected, infrastructure spending could the be the hardest to get past Congress, so if Trump rolls back on some of his spending rhetoric to try and win the support of Congress then the financial markets may not be so impressed. It is worth noting that Fed vice-chair Fischer said last week that there is a large amount of uncertainty regarding the President’s fiscal plans, that doesn’t seem to worry the markets right now.

Last but not least, it appears that European fears are causing worries as election risks rise – the Netherlands goes to the polls next month followed by France and Germany later this year – and Greek debt fears start to raise their head once more. This could be a major driver of markets this year, with the potential for even more US outperformance vs. Europe, at least in the coming weeks.

Watch the dollar for clues on stocks

The dollar had a strong performance last week, up more than 1.5% against its major trading partners. Interestingly, CFTC data suggests that dollar longs are being scaled back, particularly against the euro and the Japanese yen. This is worth watching, due to the positive link between the dollar and US stock market performance since November 2016. Although positioning hasn’t significantly impacted the performance of the dollar yet, if it is an early sign that the dollar could be peaking, then it could have ramifications for the performance of the US stock market going forward.

What to watch for this week:

Fed chair Yellen could be the biggest hurdle for further positive performance for the dollar this week. She testifies to Congress on Tuesday and Wednesday, and all eyes will be on anything she has to say about the recent weakness in wage data and thus the timing of the next Fed rate hike, her thoughts on shrinking the Fed’s enormous balance sheet, and any thoughts on Trump’s fiscal stimulus.

Also worth watching this week is UK CPI, employment, wage and retail sale data. We expect to see rising CPI and weaker retail sales. Overall, that could be a toxic mix for the pound, especially if rising prices are seen to be already restraining consumption. GBP/USD managed to hold support at 1.2415-35 last week; if it breaches this level then we could see back towards 1.22 – the end of Jan lows.