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US markets at risk of ‘sharp retrenchment’

By Killian Plastow
3 minute read

Fiscal promises made by US President Donald Trump have buoyed US equity markets in recent days, but political infighting could stifle these efforts and lead to a market correction, according to Natixis Global Asset Management.

Commenting on remarks made by Mr Trump in his recent congressional address, Natixis chief market strategist David Lafferty said disagreements within congress had a “real possibility of derailing the president’s fiscal promises”.

“If these promises have been driving equity markets upward since the election, and we have little doubt they’re the dominant reason, the market is at real risk of a sharp retrenchment once this reality sets in,” he said.

Additionally, Mr Lafferty cautioned that even if congressional Republicans “roll over” and allow Mr Trump to pursue his fiscal goals for the country, the tax cuts and increased government spending would also have consequences for the market by driving inflation upwards.

“With inflation already nearing or above 2 per cent (depending on which measure you use) and an economy near full employment, this type of fiscal ecstasy will almost surely bring about more inflation – and a more aggressive response from Ms [Janet] Yellen and her colleagues at the Federal Reserve,” he said.

“In an economy still grounded in credit in all its forms (public, corporate and consumer), higher interest rates could certainly throw cold water on the market’s recent bliss.”

While it is possible for Trump’s fiscal expansion to go ahead without being “undone by higher rates and tighter monetary conditions”, Mr Lafferty cautions that it is a very unlikely scenario and “not one that investors should be betting on”.

“We expect a market correction at some point in 2017. This is hardly an outlier prediction: historically, market corrections happen almost every year, if defined as a 10 per cent or greater peak-to-trough loss,” he said.

“Our only point is to isolate a likely proximate cause; that is, a failure in implementation of Trump’s stimulus or the offsetting risk that it will be undone by more restrictive monetary policy. Simply put, the market has gotten ahead of itself by pricing in too much optimism.”

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