NN IP: Super Thursday

(Foto: Valentijn van Nieuwenhuijzen, Head of Multi Assett; Patrick Moonen, Principal Strategist Multi Asset)

Markets have been calm, and we have discussed extensively what to think and whether to worry about this. For those looking for a bit more action, there is always hope. History may often rhyme but it does not repeat itself reliably, so it might well be that some new political or policy drama might be successful where Brexit or the US and French elections have failed. Maybe this Super Thursday will finally push market volatility sustainably higher and drive risk premia to the elevated levels where pessimistic investors and pundits feel they should be. Nothing “super” for investor returns if it were to happen, but the cocktail of an highly anticipated ECB meeting, an even more eagerly awaited testimony by former FBI chief James Comey and an unexpectedly tight UK election certainly has the potential to intoxicate markets.

The key question is whether the cocktail’s effects will do lasting damage to markets and the global economy. To see how likely this is, let’s run through today’s events. First and foremost is the ECB’s regular meeting, which takes place against the background of an ever-stronger European economy. This has strengthened the voices, mainly those in Northern Europe, that argue that it is time to start unwinding the easing measures that the ECB has taken in recent years. At the same time, a dark cloud floats on the horizon of a European version of the infamous "taper tantrum" drama that erupted when the Fed starting hinting at a removal of QE in May 2013. It created one of the biggest market corrections of the last five years, not something the ECB would be eager to unleash at this point in time, to put it mildly. Still, it drove down markets for a month or two, but it didn't trigger a real bear market. Most losses were mostly recovered and many previous highs were even surpassed in the rest of that year.

Second, a damaging statement by Comey in his testimony to Congress today might further erode the credibility and effectiveness of US President Donald Trump. However, there is already little left in market pricing of the hope that Trump would boost markets with fiscal stimulus through tax reform and infrastructure spending. It also remains highly unlikely that any evidence of Trump’s effort to influence the direction of an FBI investigation will be enough to jeopardise his presidency. Only if a sizeable portion of the Republican party were willing to join forces with the Democrats in Congress to initiate an impeachment procedure would the future of President Trump really be in danger. The political reality in Washington continues to suggest that Comey's comments will be unlikely to achieve that, no matter what he might say.

It could still be enough to occupy markets for a while. A few days, maybe, or at most a week or two. But as long as Trump stays in power, the situation is relatively clear for markets: no more Trump support, focus on strong underlying fundamentals. In such a situation lasting damage to investor sentiment remains unlikely as the recent history of political shocks such as the Brexit vote and Trump’s election has taught us all that underlying fundamentals matter more to markets than political drama.

This also says a lot about the possible impact of the UK election on global markets. The vote will basically be a sideshow. To be sure, it will be important for UK assets and perhaps especially for the nation’s currency, but for the rest of the world it will do little more than tilt the needle a bit on the Brexit compass between the "hard" and the "soft" outcomes. That may not even happen in a very decisive manner, as the political landscape in the UK might well become even more dispersed and confusing. Such an adjustment in expectations within a range of different types of Brexit scenarios is relatively marginal compared to the vast difference between the bi-nary choice of remaining in the EU or separating from it. That choice has been made; the rest is no longer a dominant factor for global markets. It might add to some volatility on the day, but seems even unlikely to still be on market's mind after the weekend.

So, Super Thursday does have the potential to shake things up, especially if the tail risk of all three events surprising negatively occurs. The dominant force in terms of size, reach and durability is probably the message coming from the ECB. Not so much its assessment of the risks surrounding growth and inflation, but hints of implications for the future of the QE program will be crucial. Unlike the market’s possible read-through of the Comey testimony and the UK election, a shift in thinking of the ECB QE program could well drive markets for a number of weeks, if not months. Given that the ECB is very aware of this risk and has acknowledged it publicly, it is not our base-case expectation that a European tamper tantrum will be triggered.
We do acknowledge however that no matter how hard Fed Chair Bernanke tried to send a message of gradualism and moderation when he started to hint at tapering of QE in the US in May 2013, the markets still got a big scare out of it in the weeks that followed. Communicating about monetary policy has never been easy, and communicating about a reversal in unconventional policy like QE is even harder. The risks around our base case are therefore tilted to the downside, especially for global bond markets. This is also where we continue to keep our most negative view on the future return potential in markets amongst the different asset classes. On other parts of the markets we remain modestly constructive on the back of the ongoing global recovery.