by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets breathed a great sigh of relief as the first round of the French presidential election went about as expected.  Macron and Le Pen will square off on May 7^th to decide the presidency.  Current polls show Macron with a commanding lead, generally 20 points or more.  Although we have seen electoral surprises recently, they have all been within the margin of error.  For Le Pen to make up 20 to 25 points would require a significant event, e.g., major terrorist attack, political scandal of epic proportions or campaign error that seriously undermines Macron’s character.[1]  Although we do expect Macron to win, we also expect a tighter vote than the current polls suggest.  Macron has no real party and so he will not have the usual “get out the vote” apparatus in place.  It’s important to note that nearly 40% of the first round votes went center-right and far-left; it isn’t inconceivable that turnout could be low.  Current polling suggests that Le Pen will only gather a small part of Mélenchon’s 19%, with the majority going with Macron and a rather large number spoiling their ballots by abstaining.  Most of Fillon’s voters will end up with Macron as well.

Although Macron will keep France in the EU and the Eurozone, which is a market-friendly outcome compared to Le Pen, he is far from an ideal candidate.  First, he has no party; there is no framework in the Fifth Republic for when a president has no representation in the Assembly.  He will be forced to select a PM that will be acceptable to whichever party wins in the June legislative elections.  Thus far, we haven’t seen any reliable polling for the legislative elections but, given the collapse of the center-left in this election, the most likely outcome will be a center-right domination of the Assembly.  Macron can probably function with that outcome.  Second, Macron is a political novice.  French voters wanted change in this election, something we saw in the U.S. (arguably since 2008) and with Brexit.  Assuming a Macron win, it is simply unknown whether France is in competent hands.

Therefore, we believe the worst outcome has been avoided but this outcome isn’t necessarily good for financial markets because it is further evidence that the center-left and center-right coalitions that have mostly ruled the West since WWII are struggling to maintain their hold on power.  The strong rally we are seeing in equities (with one exception, discussed below) along with the drop in gold, the JPY and Treasuries is consistent with “risk on.”  However, much of this rally is probably due to investors reversing positions designed to protect themselves from a negative outcome in these elections.  If that is all it is, the rise should mostly be contained within the next few days.

The one interesting divergence from the global equity rally is China.  The Shanghai Composite has been stumbling recently in what seems to be caused by growing worries of rising interest rates.

Note that Chinese equities have been coming under pressure over the past two weeks.  The drop coincides with rising interest rates.

The Xi government is worried about the high levels of Chinese debt and reports of rising non-performing loans.  As the PBOC clamps down on lending, rates are rising which appears to be pressuring equities lower.  The Xi government is working to maintain stability and growth as the CPC conference that will elect him to a second term convenes in October.  Thus, we don’t expect the regime to allow for a major market drop or a financial crisis to develop…at least if it can control such things.  So far, the drop in Chinese equities appears to be nothing more than a normal market retracement, but more significant declines may be forthcoming if we break the 3100 level on the Shanghai Composite.

Finally, President Trump surprised his aides by indicating that a tax proposal will be outlined on Wednesday.  We don’t expect anything other than the broadest of brush strokes but this announcement does suggest he is trying to make a splash around his first 100-day mark.  We also don’t expect a government shutdown on Saturday, although we have to say that negotiations don’t seem to be going well.  The opposition isn’t planning on voting for a border wall and the GOP may reduce funding for the ACA’s subsidies so the potential for a closure is in place.  We believe the president doesn’t want a shutdown this early on his watch so he will likely stand down, but anything is possible given the mercurial nature of Mr. Trump.  We continue to watch the markets but clearly today there are no concerns about a government closure.

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[1] https://www.youtube.com/watch?v=yTO5AYl1zCs

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] On Sunday, the French go to the polls.  The most recent polling shows Macron as the most popular candidate at 24.0%, with Le Pen second at 21.5%, Fillon at 20.0% and Mélenchon at 19.5%.  Polls open at 8:00 am (CEST), which is 2:00 am EDT, and close at 7:00 pm, or 1:00 pm EDT.  Exit polls are technically not legal but usually information begins to emerge from other European nations throughout the day.  Final results could take a few days so we may not know the outcome on Monday.  The president needs a majority to win and if no candidate gets more than 50% then a runoff election will be held on May 7.

Until recently, it looked like a two-person race, with Le Pen and Macron likely to face each other in a runoff.  However, polls have tightened considerably and it is possible that either Fillon or Mélenchon could make it to the second round.  For the financial markets, the best outcome would be Fillon, who is center-right, facing Macron, a centrist.  Neither man has called for a withdrawal from the Eurozone or the EU.  The worst outcome would be Le Pen and Mélenchon in a runoff.  Both are populists, with the former coming from the right and the latter from the left.  Both have an anti-euro and anti-EU policy platform.  The most likely outcome is still Le Pen and Macron, but turnout will be key.  Polling suggests that Macron’s support is shallow and a low turnout will tend to support the more radical candidates and lead to a Le Pen/Mélenchon runoff.   It should also be noted that undecided voters make up about one-third of the electorate; to be undecided at this stage may signal a low turnout.

What has been lost in the focus on the presidency is that legislative elections are scheduled for June 11.  Both the National Assembly (lower house) and Senate (upper house) hold elections on this day.  The voting is rather complicated and usually leads to a runoff that will be held on June 18.  The bottom line is that the president’s powers are affected by legislative support.  If the president’s party fails to gain a majority in the Assembly, the president’s ability to affect policy is severely limited.  The French system is “semi-presidential” in that the domestic agenda is run by the prime minister, while foreign and defense policy lies with the president.  The president appoints the PM but the Assembly has the ability to force out any PM they don’t like.  Thus, without a secure majority in the National Assembly, the president is essentially forced to choose a PM that may be in the opposition.

Only Fillon comes from a large national party.  The other three leading candidates represent small parties, with Macron having recently created his.  Accordingly, if one of these three candidate wins, it is highly likely they will be forced to select a PM that doesn’t really represent their policy positions.

Even if the worst outcome occurs, in reality, the ability of the new president to force through a radical agenda will be limited.  At present, polling is limited but it appears that no party will gain a majority in the Assembly, meaning that the president will likely need to govern with a coalition and appoint a PM that is amenable to the newly elected members.  The most likely outcome is gridlock.  At the same time, the election of Le Pen or Mélenchon would upset the financial markets because it would show rising discontent with the EU and Eurozone and provide further evidence of rising populism.

From the beginning of the Trump administration, we have postulated that the president would need to vacillate between two poles, the establishment and the right-wing populists.  And, for all the fury and noise, that is what he has done so far.  On financial regulation and reducing government oversight, Trump is executing a mostly establishment GOP position of smaller government.  At the same time, on immigration and trade, the president is clearly populist.  Border walls and enhanced deportations show his position on immigration.  Yesterday, we saw more evidence on trade as the administration prepared actions to protect steel.  We expect this pattern to continue.

As we approach the 100-day mark of Trump’s presidency, there are reports of a flurry of activity coming from the White House.  These include a new attempt to overturn the ACA, money for a border wall and more executive orders on regulation.  The problem is that we are also facing a funding deadline which requires legislation in order to keep the government functioning.  These initiatives from the White House are reportedly interfering with efforts to keep the government running.  Although we don’t expect a government shutdown, we do expect a “Twitter storm” from those saying the administration got a lot accomplished in its first 100 days and from those who suggest it was a bust.  In reality, the 100-day mark is not all that important but the charges and countercharges would be a distraction in the coming days.

Yesterday, equities got a boost from SOT Mnuchin’s promise that the administration will have tax reform completed by year’s end.  Although we doubt there will be any major reforms by then, we would not be surprised to see “reform lite,” which would likely include a modest cut to rates (5% max) and a repatriation deal.  Even that could lead to a widening of the deficit.  To counter this problem, it appears the administration will rely on faster future growth to fund the tax cuts, a process formally called “dynamic scoring.”[1]  If the growth fails to materialize, the deficit would widen.

Finally, tensions on the Korean peninsula remain high as North Korea appears poised for a nuclear test.  There are unconfirmed reports that the Chinese and Russian militaries are on alert.  All we are seeing is rhetoric and some degree of preparation, but there is always the potential for a mistake.  So far, the financial markets have ignored this issue, mostly because there is always some degree of tension in this part of the world.  Still, as we have noted before, we have a young leader in North Korea who appears insecure in his position and thus may be prone to rash actions.

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[1] http://www.reuters.com/article/us-usa-tax-trump-idUSKBN17M2PQ

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] In Georgia, Jon Ossoff fell short of achieving the 50% threshold needed for him to win the vacant House of Representatives seat in Georgia. As a result, Ossoff will face Karen Handel, the Republican candidate, in a run-off on June 8. His surprise showing has breathed fresh life into the Democrat Party, which sees Ossoff’s success as a sign of growing dissatisfaction with the GOP. As mentioned in yesterday’s report, the seat is inconsequential in terms of a power shift in the House, but it could be a positive sign for what Democrats can expect in the 2018 mid-term elections. There are 34 Senate seats up for grabs in 2018, 25 of which are held by Democrats.

On Tuesday, the Trump administration informed Congress via letter that Iran has complied with the nuclear agreement, also referred to as the Joint Comprehensive Plan of Action (JCPOA), but the administration is concerned about Iran’s role as a state sponsor of terror. Under the terms of the deal, the White House is required to notify Congress every 90 days of Iran’s compliance. During the election, Trump referred to the JCPOA as “the worst deal ever negotiated” and imposed new sanctions on Iran in February after evidence surfaced of ballistic missile tests. The letter goes on to say that the National Security Council will continue to evaluate whether sanctions should be suspended and would only do so if it is in the best interests of national security.

In other news, Trump signed a new executive order broken into two parts, “Buy American” and “Hire American.” The first part is aimed at preventing abuses of the H-1B program, in which tech firms look to cut costs by hiring highly skilled foreign workers. It also seeks advice for changes in the program that would favor highly skilled workers with advanced degrees. Currently, the program admits 65,000 temporary immigrants with at least a bachelor’s degree in addition to 20,000 immigrants with advanced degrees. The second part of the order requires federal agencies to purchase more U.S.-made goods when possible. The executive order appears to be a response to recent criticism of perceived policy reversals by the Trump administration.

In Japan, VP Mike Pence reassured leaders of the U.S. commitment to reigning in North Korea as well as promoting economic ties. Pence stated that the U.S. is looking into additional economic sanctions that would deter North Korea’s nuclear program. His visit was seen as a success by many leaders who feared Pence would use the occasion to express disappointment in the current trade relationship. Japan currently has a trade surplus of $10 billion with the U.S. and Trump has frequently criticized it for unfair trade policies. It is worth noting that earlier this week Pence had criticized South Korea for its treatment of American businesses.

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by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Here are some of the news items we are following this morning:

PM May calls snap election: Reversing her earlier stance, Theresa May has called for a general election on June 8.  The previously scheduled election wasn’t due until 2020, but there are rising tensions that will come from Brexit and the Tories lead Labour by 21 points and will likely lift that margin in Parliament significantly.  Snap elections have become quite rare; the last voluntary early election was October 1974.  In 1979, an election was called after the Labour government lost a no-confidence vote.  May will need two-thirds of Parliament to actually get permission to dissolve the government.  It looks like that will be a formality.  Given that May took control of the government without an election (she took over for David Cameron when he resigned following Brexit), winning an election would give her a more solid mandate.  It would also allow her to jettison her predecessor’s policies and put forward her own goals for government.  The GBP initially fell on the announcement but has rebounded strongly since; a stronger mandate would be bullish for the currency as it would give May a stronger bargaining position with the EU.

Special election in Georgia: There will be a special election today in Georgia’s sixth Congressional District to replace Tom Price, who resigned the seat to become HSS Secretary.  It is generally a strongly red district (Price won it by 23 points in 2016), but it does appear that Democrat Jon Ossoff, a former congressional staff member, will win the most votes.  To win the seat, the winner must garner a majority.  If no candidate gains a majority, a runoff will be held.  There are a number of viable GOP candidates that are splitting the Republican electorate and so it is highly unlikely any of them will threaten Ossoff in the first round.  However, Ossoff would be quite vulnerable in the second round.  Thus, if the Democrats are going to flip the seat, they probably have to do so in the first round.  Although losing the seat won’t change the House, it will be a political embarrassment to the White House.

French elections: The polls are turning into a four-candidate race, with Macron and Le Pen still holding in the mid-20s but Mélenchon (hard-left) and Fillon (conservative) approaching 20%.  Undecided voters are still running as high as 20% in some polls so it is possible that the expected Le Pen/Macron second round could have another combination.  The NYT[1] reports that Russia is being accused of actively trying to sway French voters; the Kremlin seems to be supporting Fillon and Le Pen.  Both are considered right wing and anti-EU.

New BOJ board members: The Abe government named two new members to the BOJ, replacing two whose terms had expired.  Takehiro Sato and Takahide Kiuchi are leaving the BOJ; both are hawkish.  They are being replaced by Goushi Kataoka and Hitoshi Suzuki, both from the private sector.  The former is considered quite dovish while the latter is more neutral.  Thus, the composition of the board is considerably less hawkish.  This should be a bearish factor for the JPY.  Given the recent strength in the currency, we would look for this rally to stall and reverse based on the news.

More on Quarles: Yesterday, we noted that there are strong indications that President Trump will nominate Randal Quarles to governor of the Federal Reserve, filling one of the three open spots on the FOMC.  Quarles is being appointed to a specific role at the central bank, one concerned primarily with regulation.  His views on regulation appear consistent with David Tarullo, who had unofficially taken on this role and recently resigned.  He does not favor increasing bank capital but does want to give regulators specific powers to liquidate banks, even those considered “too big to fail.”[2]  However, the surprise from Quarles may come on monetary policy.  He is, apparently, a proponent of rules-based monetary policy, suggesting that discretion-based policies politicize the central bank and lead to policy mistakes.  Although that is true, going to rules won’t necessarily protect the central bank from politicization either; the rules don’t come down from Mount Sinai but are made by people with political agendas.  In addition, no rule can cover all circumstances and people will be likely to intervene even in a rules-based environment.  Based on his stance, we would likely score him as a two-star hawk with a tendency toward a single-star hawk.

Oil prices: Yesterday’s WSJ[3] carried a report that OPEC’s largest producers are targeting oil prices at $60 per barrel.  Bloomberg reported today that Saudi exports have fallen to 6.95 mbpd, the lowest level since May 2015.  Compliance has been high among the cartel members.  The report carried this interesting quote, “They [the Saudis] need this price [$60] for the IPO of Saudi Aramco.”  Although current stockpiles and dollar strength don’t support prices at current levels, it is clear that the kingdom, in what can best be described as “window dressing,” is propping up the price of oil for this IPO.  This move will give U.S. shale producers an opportunity to boost output and take share from the cartel, at least until the IPO is priced next year.  What happens after that could be problematic but, for now, OPEC action will be supportive.  We have serious doubts that $60 can be reached unless the dollar tumbles because the inventory overhang looks to be with us for a while.

Mnuchin speaks: Yesterday, Treasury Secretary Steven Mnuchin granted interviews to the media and indicated that tax reform won’t happen soon and that the U.S. will maintain the “strong dollar” policy.  As we noted before, this policy isn’t designed to actively boost the dollar but to avoid exchange rate volatility by threatening to intervene to sway the currency.  The dollar lifted on the news as it seemed to suggest that the Rubin strong dollar policy would remain in place.

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[1] https://www.nytimes.com/2017/04/17/world/europe/french-election-russia.html?emc=edit_mbe_20170418&nl=morning-briefing-europe&nlid=5677267&te=1

[2] Our position, for what it’s worth, is that this stance doesn’t work in the real world.  Regulators are captured by those they regulate and institutions that are too big to fail are too big to orderly liquidate.  Assumptions that the government has the power to protect the financial system even from the failure of very large banks embolden banks to take risks and regulators to give too much room to operate for banks on the basis that they can address any crises.  Instead, the goal, IMO, is better served by forcing banks to hold more capital.

[3] https://www.wsj.com/articles/saudi-arabia-iraq-kuwait-aim-for-60-a-barrel-oil-price-1492176010

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Erdogan narrowly wins: In Turkey, it appears that voters have approved major changes to the political system by a 51% to 49% margin.  There were reports of widespread voter irregularity and the opposition has announced it will formally protest the vote.  The new laws will dramatically boost the power of the presidency, changing it from a mostly ceremonial, non-partisan post to an executive presidency with wide powers.  The parliament will see its powers reduced, requiring supermajorities to open investigations on any of the president’s deputies or ministers.  The president will effectively be able to govern by decree and can dissolve the parliament at will.  He will also be able to appoint deputies, ministers and some judges without legislative oversight.

The new powers won’t go into effect until the next president is elected; elections are not scheduled until November 2019.  Although a spokesman for Erdogan said that he isn’t planning snap elections to take advantage of these new powers, it seems unlikely that he will wait that long.  The president can serve two consecutive five-year terms but can sit for a third if elections are called before the second term ends.

We will be watching for two signals.  First, will the opposition’s voter fraud charges have any impact, and second, assuming the first matter fails, will the opposition accept the results without political and social unrest?  On the first point, we doubt the charges will stick.  There were numerous media reports suggesting uncertified ballots were counted.  This could be a form of ballot box stuffing, but we doubt Erdogan will take these charges seriously.  On the second point, given how close the vote was, we would expect some degree of tensions.  We doubt these issues will have too much effect on financial markets.  European powers have indicated some unease over the results, but the threat of a refugee flood will likely quell these concerns.

North Korea: It was the 105^th birthday of the founder of the DPRK, Kim Il-sung.  Such occasions usually bring some sort of tests to show North Korea’s prowess.  Although it does appear the country is preparing a nuclear test, it opted for a missile launch which apparently exploded on takeoff.  While incompetence should never be discounted, there was some speculation in the analyst community that U.S. cyber efforts may have played a role.  VP Pence is in South Korea and reiterated the line about the “end of strategic patience.”  We also note Bloomberg^[1] is reporting that President Trump is considering a “sudden strike” on North Korea, although the preferred policy is for China to undermine the Kim Jong-un regime.  With steady escalation, Robert Litwak of the Woodrow Wilson International Center for Scholars describes the situation as “the Cuban missile crisis in slow motion.”^[2]  Although the financial markets have not done much with the North Korean situation (the JPY would likely be weaker if a war was imminent because Japan would almost certainly be a target), the odds of escalation are probably higher than before.  North Korea is getting closer to a deliverable nuclear weapon and no amount of sanctions appear able to deter that steady progress.  At some point, the U.S. will either need to attack North Korea to slow or stop its progress, negotiate a slowdown or live with a nuclear Kim regime.  The second option is preferred but also the least likely.

We have recently noted the growing political polarization of the country.  This chart shows that it even affects views on the economy.

This chart measures perceptions of the economy by voters in Wisconsin based on political party.  Note that during the 2012 elections, Republicans were far more despondent about the economy than Democrats.  The recent flip is notable and has probably affected some of the well documented improvement in the survey data.  What is also interesting about the data is that Democrats seldom become overly bearish on the economy, whereas GOP voters seem to have rather violent mood shifts in their outlook.  We do want to note that this is only one state but it does reflect national data, although the shifts are less pronounced.  If GOP voter hopes become dashed due to the lack of progress on taxes and other fiscal measures, we could see a reversal in the survey data.

President Trump has indicated that he is likely to select Randy Quarles to the FOMC for the top regulator post.  The Dodd-Frank bill created a role on the FOMC for a governor dedicated to regulation.  This post was never officially filled, but the recently retired David Tarullo had informally filled the position.  Quarles is considered a moderate and was a Treasury undersecretary in the Bush administration.

On Good Friday, the BLS released the consumer price index for March.  The data came in surprisingly soft.  On a yearly basis, the core rate fell 20 bps to 2.0% while the overall rate dipped 30 bps to 2.4%.

Lower inflation did affect the Mankiw Rule model results.  The Mankiw Rule models attempt to determine the neutral rate for fed funds, which is a rate that is neither accommodative nor stimulative.  Mankiw’s model is a variation of the Taylor Rule.  The latter measures the neutral rate by core CPI and the difference between GDP and potential GDP, which is an estimate of slack in the economy.  Potential GDP cannot be directly observed, only estimated.  To overcome this problem with potential GDP, Mankiw used the unemployment rate as a proxy for economic slack.  We have created four versions of the rule, one that follows the original construction by using the unemployment rate as a measure of slack, a second that uses the employment/population ratio, a third using involuntary part-time workers as a percentage of the total labor force and a fourth using yearly wage growth for non-supervisory workers.

Using the unemployment rate, the neutral rate is now 3.45%.  Using the employment/population ratio, the neutral rate is 1.22%.  Using involuntary part-time employment, the neutral rate is 2.65%.  Using wage growth for non-supervisory workers, the neutral rate is 1.35%.  Outside of the unemployment rate, the labor market data was soft.  Coupled with weaker than expected inflation data, two of the variations have us approaching policy neutrality.  Weak wage growth and a stagnant employment/population ratio would suggest the FOMC is roughly one hike away from achieving a balanced policy.  This may be what the dollar and Treasury markets are concluding.

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[1] https://www.bloomberg.com/news/articles/2017-04-16/mcmaster-rules-nothing-out-as-trump-team-mulls-north-korea-moves

[2] https://www.nytimes.com/2017/04/16/us/politics/north-korea-missile-crisis-slow-motion.html?rref=collection%2Ftimestopic%2FCuban%20Missile%20Crisis%20(1962)&action=click&contentCollection=timestopics&region=stream&module=stream_unit&version=latest&contentPlacement=1&pgtype=collection

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] In a wide-ranging interview, President Trump roiled the markets late yesterday by admitting that (a) China is not a currency manipulator; (b) the dollar is too strong; and (c) Chair Yellen might be invited to stay at the FOMC.  Point (b) was the market-moving news; since Bob Rubin was Treasury Secretary during the Clinton administration, the White House has hewed to a “strong dollar” policy.  Essentially, this policy was designed to end the practice of currency manipulation by the government.  For the most part, the U.S. has allowed the dollar’s level to be set by market forces.[1]  Earlier, the Trump administration signaled that the Rubin dollar policy was coming to an end and active discussion of the dollar’s level was possible.  The president’s position that the dollar is “too strong” suggests the administration would like to see it weaken.

This policy of “oral intervention” is often effective in the short run.  Whether it has a long-term effect depends on two factors.  First, is the jawboning followed up with policies that change the fundamentals for the exchange rate?  And second, what is the valuation of the currency when the jawboning takes place?  Currently, on a relative inflation basis, the dollar is expensive relative to the JPY and EUR.  For the most part, the dollar’s strength since 2014 has been a function of tighter monetary policy.  In fact, based upon the current level of the two-year T-note, the EUR/USD rate should be closer to parity.  It appears to us that the exchange rate markets are waiting to see how much more U.S. monetary policy tightens and whether other central banks are coming close to ending their overly easy policies.  A president suggesting that he wants a weaker dollar does, at least in the near term, signal the potential for a weaker currency.  However, we would also note that most presidents prefer dollar weakness on hopes it might boost growth.  Even President Reagan, who supported dollar strength initially, reversed course on currency policy in his second term.

If the dollar is poised to fall, it would change our outlook for some markets.  Emerging markets have been unusually strong relative to the dollar, which may suggest that investors in these markets anticipated a reversal in the greenback.  Although dollar weakness is usually bullish for emerging markets, we would argue that much of that has already been discounted.  Commodities usually benefit as well.  As we note below, oil prices arguably have discounted some dollar weakness, too.  A weaker dollar tends to support large caps relative to small caps and that trade may have some room to move further.  But, it is too early to tell if yesterday’s weakness will stick.  After all, the FOMC is still expected to make at least two more hikes and the balance sheet will likely be trimmed, so a weaker dollar has to occur with tightening policy.  That might be a struggle.

The interesting issue surrounding the decision not to name China a currency manipulator is that Trump actually has already received the key response to naming a nation a currency manipulator, namely, bilateral negotiations designed to reduce the trade imbalance.  China does, in fact, manipulate its currency but in a way that is positive for U.S. trade; left to its own devices, the CNY would be much weaker.  By getting trade talks without naming China a manipulator, which would have been difficult based on the Treasury Department’s criteria, Trump has managed to get what he wanted anyway.

On the Yellen comment, we think it’s best to frame it relative to what we see going on in the White House.  Since the election, we have discussed this presidency as “Bannon v. Ryan.”  Bannon is losing ground fast.  Jared Kushner appears to be the president’s most trusted advisor, and he is steering Trump toward a conventional GOP establishment position.  This not only excludes the populists but also the Freedom Caucus, which is pre-Rooseveltian.  In other words, this is becoming a country club GOP administration.  That being said, the other characteristic of this administration is that it consists of mostly tactics with little clear strategy.  When the president cites “flexibility” we see the lack of clear goals.

If we are correct, it is good news for financial markets.  The inflation-generating policies that the populists want would weigh on stocks and bonds.  Instead, we will likely see “middle of the fairway” policies—the ACA mostly stays intact, modest tax cuts occur, trade impediments are mostly for show and the superpower role will remain intact.  On the other hand, the populists aren’t going away.  If this is the correct assessment of the trend, it will open the door for either a right-wing populist to mount a GOP primary challenge or, more likely, a “Bernie-crat” challenge from the left.  The latter assumes that the Democrat Party understands the populist-establishment dynamic, which is questionable.  So, we will continue to watch this development closely, but this is what we are seeing.

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[1] U.S. dollar policy has always been an odd configuration; the Treasury has the mandate for policy but the most effective tools for short-term exchange rate management are interest rates, which are the purview of the Fed.  The Treasury was mostly left with jawboning the markets, which isn’t a good long-term strategy.  Rubin decided that it made the most sense to say the U.S. wanted a strong dollar without defining what that meant.  That decision has left subsequent Treasury Secretaries to maintain the language without content.