US Economy

These two markets are getting really worried about Trump political risk

President Donald Trump in the Oval Office of the White House in Washington, DC.
Jabin Botsford | The Washington Post | Getty Images

Two key market gauges, followed closely for what they say about the economic outlook, look to be rethinking the policy possibilities of President Trump.

Both the dollar and bond yields have been under pressure this week, reflecting "reduced likelihood that the GOP will be able to advance the Trump Administration's economic agenda," wrote RDQ economists John Ryding and Conrad DeQuadros.

Sudden dollar jump

A weekly report from JP Morgan Global FX Strategy said, "The sharp market reaction to this week's news from Washington is understandable, as impeachment risk has gone from negligible to non-negligible."

The spread between the yields of the 2-year and 10-year notes, which surged after the election, has now done a complete round trip. The steeper the spread, the more the market is betting on inflation and growth. The spread had increase to 1.35 percent, and is now just 0.96 percent.

Three straights months of progressively lower inflation, along with weak first quarter growth, hasn't helped. But yields are weakening just as many economists see both growth and inflation ticking up. "Political events drown out economic growth," Barclays wrote in a report Friday. "The global expansion remains intact, with the US taking the lead in Q2."

The dollar has done a similar round trip, with the DXY basket of currencies rising from 98 on election to 103 in late December. It's now barely above 97. Partly this reflects better growth prospects in Europe and the chance monetary policy on the continent won't be uber-dovish forever.

But the case for a strong dollar initially centered on tough trade policies expected from the Trump administration. Since the president has been in office, China was declared not be a currency manipulator and a threat to scrap NAFTA has become negotiations over NAFTA.

"The greenback's decline seems excessive in that an impeachment is unlikely, while the normalization of the Federal Reserve's policy will continue, which ought to bolster the US dollar. We therefore expect the greenback to firm in coming weeks," said Natixis Economic Research in its weekly forex roundup.

The probability for a quarter point hike from the Federal Reserve in June traded at about 70 percent, having falling from 84 percent earlier this month, seemingly driven in part by a barrage of worse news from the White House. The chance of a third hike this year coming in December has fallen below 50 percent.

The stock market doesn't seem as worried. After dropping 373 points on Wednesday as the Trump political risk fears intensified, the Dow Jones industrial average recovered on Thursday and Friday, making back more than half of the decline.

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