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How the Trump trade became the Trump fade

Call it the Trump fade?

The so-called Trump trade captivated Wall Street after the surprise election of Donald Trump last November. After years of stagnant economic growth in the wake of the financial crisis, the prospect of Mr Trump’s pro-business agenda, combined with Republican control of both executive and legislative branches of the US government, breathed new life into the ageing equity rally, sent the dollar to its highest levels in 14 years and threatened to finally end an epic, multi-decade bull market in bonds.

While the Trump trade had already fizzled this year as Mr Trump’s plans prove harder than hoped to enact, reports that Mr Trump sought to interfere in an FBI investigation sent key market benchmarks back down to levels last seen before the election.

The concern is that controversies surrounding the US president will affect efforts to push ahead with plans for tax cuts, infrastructure spending and deregulation, all of which were seen as boosting economic growth and corporate earnings.

“The risk premium related to policy uncertainty has gone up,” said Devin Ryan, a managing director at JMP Securities.

Currencies

The US dollar has given up all the gains made after the election as hopes that Mr Trump would turbocharge the US economy relative to its peers have receded.

The dollar index, which measures the greenback against a basket of other currencies, fell 0.62 per cent to 97.49 on Wednesday — the lowest level on a daily fix basis since November 4, according to Bloomberg data. That is a 6 per cent decline from its peak.

While business and consumer confidence has remained high, US economic data have been choppy at best at a time when other trading partners, particularly the eurozone, are experiencing a brightening in sentiment.

The yen’s performance against the dollar was particularly strong on Wednesday, with the greenback off 1.9 per cent to ¥110.96. The Japanese currency tends to perform well during times of higher geopolitical tension. Meanwhile, the euro gained 0.71 per cent on the dollar, settling above $1.11 against the dollar for the first time since the US election, and the UK pound rose 0.4 per cent.

Stocks

News that the Justice department has appointed a special counsel to investigate the Trump campaign’s ties to Russia came long after the end of the trading day, but the mounting political furore had already sent major US equity market benchmarks tumbling.

The S&P 500, the Dow Jones Industrial Average, the Dow Jones Transportation Average, the Nasdaq Composite and the Russell 2000 all recorded their biggest one-day declines since before the election.

The big gainers on Wednesday were bond proxies, such as real estate investment trusts and utilities, which — just like US Treasury bonds — typically draw buyers when investors are reducing their risk.

The equity market indices had all been hitting record highs in recent months but, beneath the surface, a sector rotation has been under way that reflected doubts about the Trump agenda.

Investors had been moving away from financials and energy stocks, which were seen as likely beneficiaries of the administration’s deregulation agenda or fiscal policies that might stoke inflation and push interest rates up.

A market measure of long-term inflation expectations known as the 10-year break-even rate fell further below its pre-election level on Wednesday. The “Trumpflation” expectations that drove stock gains just after the election had already given way among equity investors to a focus on buoyant profit growth at US companies.

A five-quarter earnings recession ended in the third quarter of last year and profit increases gained momentum in 2017. In the first quarter, companies in the S&P 500 reported earnings growth of nearly 14 per cent a share, the first quarter of double-digit earnings growth year over year since the fourth quarter of 2011.

Tech, among the sectors most vulnerable to selling in market downturns, did indeed sell off sharply on Wednesday, but it has been the winner this year as these companies offer the prospect of high growth notwithstanding the underlying economy.

Government bonds

With the focus suddenly on economic and business risks from the Trump administration’s difficulties, investors sought the safety of government bonds — pushing the yield on the benchmark 10-year US Treasury yield, which falls when the price of the bond goes up, 10 basis points lower to 2.22 per cent.

That was its second biggest one-day decline since the aftermath of the Brexit vote, and it meant that the difference between short-dated Treasury yields and longer dated yields such as the 10-year narrowed.

The two-year/10-year spread “flattened” by the most it has done on any day since December. That measure is important for banks, which make money from lending at longer-dated, higher interest rates while paying lower interest on the short-dated deposits that fund their operations.

And it is the reason bank stocks were hard hit on Wednesday, with Morgan Stanley, Bank of America and Goldman Sachs all down more than 5 per cent.

Gold

Investors also turned to the perceived safe haven of gold on Wednesday, with the precious metal enjoying its best day since the immediate aftermath of the Brexit vote last June. The commodity climbed $24, or just under 2 per cent, to $1,261 and erased all of the losses it tallied earlier this month.

The spot price gain was the commodity’s fifth consecutive trading day rise, and a consequence was that exchange traded funds that invest in the precious metal or in gold miners’ stocks — including funds from iShares, SPDR and VanEck — were all up more than 1.5 per cent.

Volatility

Measures of volatility also rose with the political temperature, affecting all asset classes and geographies. The most widely watched of the volatility measures created by the CBOE, the Vix index of implied US equity volatility, which has earned the nickname of Wall Street’s “fear gauge”, had its biggest one day rise since September 2016.

The Vix remains at historically low levels, however. Breaking just above 15, it is still only back up to its highest level since April.