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Death of 'Trump trade' shifts focus to global reflation bets

The so-called 'Trump trade' which turbo-charged stocks at the end of 2016 faded in the first quarter as investors began to doubt the new U.S. president's ability to pass business-friendly legislation, correlations show, but investors are confident a broader bet on global reflation will fuel another leg up for markets.

The correlation between the dollar, U.S. Treasury yields and U.S. equities surged after Donald Trump was elected Nov. 8, 2016, and again shortly after his inauguration in January, as investors bet promised cuts to tax and regulation would boost company earnings and prompt the Federal Reserve to increase the pace of rate hikes. The S&P 500 stock index jumped 12% to an all-time high March 1, and 10-year Treasuries gained as much as 77 basis points to the highest level in three years. The dollar index touched a 14-year maximum in January.

But these relationships collapsed last month, data from Kensho Technologies Inc. shows. The 50-day rolling correlation between the ICE USDX dollar futures index and the S&P 500, at -0.34 before the election, reversed sharply and climbed to a 14-month high of 0.38 by March 1. It halved to just 0.19 by March 31.

Gauges of the risk-on mood that swept markets in the wake of Trump's victory have faltered in 2017, particularly since his failure to push healthcare reforms through Congress in March bred skepticism that he would be able to implement his fiscal stimulus plans.

But with firms globally expected to report stronger first-quarter earnings in April, there are signs the death of the 'Trump trade' will not scupper global reflation bets. The 10-year U.S. Treasury was at 2.36% on April 4, and a yield of 3% by year-end remains a popular projection as price pressures build.

"People are looking for reasons to be downbeat," said Tim Graf, head of macro strategy EMEA at State Street Global Advisors. "There is good reason to be more circumspect, but the foundations of the reflation trade were in place well before the U.S. election, and were not only present in the U.S."

"Global earnings projections remain strong and so do recent data from China that will support global growth."

The 'global reflation trade' can be traced back to mid-2016, when analysts called the end of a decadeslong bull market in bonds just as the 30-year U.S. Treasury yield reached a record low just above 2% in July. Rates have been on an upward trend since, and the 30-year yield has spent most of 2017 in the region of 3%.

Now what?

"Despite concerns about the viability of Trump's fiscal reforms, long-term U.S. rates expectations have been solid," said State Street's Graf.

"Five-year breakeven inflation rose around 100 basis points from the recent trough to peak, and that has only come off by around 10 basis points," he said, referring to the difference between yields on inflation-adjusted bonds and regular bonds, a measure of market expectations of the rate of future price increases.

Inflation expectations in Europe have also risen steadily, though a flash estimate of eurozone inflation on March 31 came in at 1.5% for March, down from 2% in February.

European assets are battling idiosyncratic risks that are clouding a more promising economic outlook, said one London-based credit fund manager.

"Europe can't seem to escape the 'what if' scenario," he said. "You've got the French election, Brexit, the Italian banks. These are all keeping people ultra-cautious when the underlying picture is perhaps much more positive."

Economic data back that view up. Eurozone factory output growth hit a six-year high in March, according to Markit, while unemployment across the trading bloc sank to its lowest since May 2009.

Spotlight on China

Chinese manufacturing growth — a key barometer for global demand — was also the highest for five years in March, according to its official purchasing managers' index, while measures of rail freight traffic and electricity and steel production have also picked up.

In a note March 31, UBS strategists said China deserved to be a greater focus of the global reflation trade.

"The reflation debate has so far revolved around the U.S. Congress' ability to sustain animal spirits," they wrote. "However, an equally significant and less appreciated driver of the improvement in global growth over the last year has been China."

Moving into the second quarter, Chinese quarterly growth remains robust, though momentum slipped in March, they said.

"And, commodity markets, which lead on the way up, have begun to show tentative signs of nervousness."

China's President Xi Jinping is set to hold talks with his U.S. counterpart on April 6 and 7, in a meeting that could set the tone for the trade relationship between the world's two largest economies for the coming years.

Trump trades toppled

The squeezing of Trump trade money from U.S. markets accelerated after a lack of support from the president's own Republican party undid a healthcare reform bill before it even went to a vote in Congress. This raised questions about whether plans including tax cuts for business and $1 trillion in infrastructure spending might suffer a similar fate.

"The speed (and even the likelihood) of possible tax reforms and deregulation are now particular concerns for many," said Franklin Templeton's trading desk in a note on April 3.

"Interestingly, companies with higher tax rates that had initially soared after the election subsequently lagged."

That includes firms such as General Electric, which investors were betting would benefit from tax and trade changes. GE shares have slumped 6% in 2017, closing at $29.88 on April 3.

The Mexican peso, which lost 18% against the dollar between Trump's election and Jan. 20 inauguration, was back trading at around $0.053 on April 4, having recouped almost all that loss.

U.S. bank shares, temporarily supercharged by Trump's talk of rolling back the post-crisis Dodd-Frank regulations, have also faltered. JPMorgan Chase & Co., which surged 34% to $93.60 between Nov. 8 and March 1, closed at $87.70 on April 3.