Forward guidance – Trump style

These are strange times in global markets. Trump’s election, previously feared as a universal negative for global markets, has been accompanied by remarkable strength in risk assets. We highlighted investor positioning as a factor last week but now question if there is there more to this rally? Could Trump’s fiscal policies represent a “whatever it takes” moment?

Central banks are no strangers to jawboning markets with policy intentions to achieve policy objectives. Forward guidance for monetary policy has long been part of policy makers’ toolkits. The intention is to maintain a set of financial conditions conducive to supporting the real economy.

However, ECB President Mario Draghi raised jawboning to an art form when he declared he would do “whatever it takes” to save the euro through “outright monetary transactions” (OMT). The policy was highly controversial and a high degree of uncertainty existed as to whether it would even be legal. But that statement of intent was enough to calm markets, stop capital flight out of the eurozone periphery and to extinguish the flames of the eurozone crisis. Four years on, OMT remains unused.

It would appear that when a bazooka is large enough it does not need to be fired to get the necessary result. In this respect, there may be a parallel with Trump’s controversial fiscal policies. We do not know what might ultimately be supported in Congress in terms of a U.S. fiscal stimulus. However, while it may sound like a confidence trick, and if OMT is a guide, policy efficacy may have a stronger link to intention, rather than action. Instead of “whatever it takes”, this time it is “Make America Great Again”.

While reluctant to meaningfully change our cautious positioning on equities, which is in any case primarily driven by valuation concerns, we would now caution against becoming overly negative in the short-term. A positive feedback loop developed in Europe following OMT, drawing the region away from crisis. At the time we were surprised just how far an effectively notional policy could carry markets. For global bond markets, we therefore believe the notable rise in yields is justified by recent events and may have further to run.

In respect of the incoming Trump administration, there remains uncertainty in terms of the size and composition of any actual U.S. fiscal stimulus, as with Draghi’s OMT. However, due to the way markets have reacted, the boost to confidence is real and immediate and the re-pricing of global markets could become self-validating as a race develops to invest ahead of the anticipated upturn in U.S. GDP growth.

Central banks do not have a monopoly on forward guidance. The success or otherwise of “signalling” policies is also very dependent on the prevailing mood of the crowd. However, investors should at least ask themselves the question: Could “Make America Great” be as powerful as “whatever it takes”?