What is clear is that much of the conviction with which investors went into 2017 has been lost. This week, Goldman Sachs ditched its long-standing bullish call on the US dollar, and Deutsche Bank did likewise with their gloomy sterling outlook.
Following the developed world's two most seismic events last year - the US presidential election and Britain's vote to leave the European Union - investors around the world had positioned for a broad-based reflation trade. Trump's surprise election victory was supposed to unleash a wave of tax cuts, banking deregulation and fiscal largesse that would lift US - and global - growth.
Meanwhile, sterling's 20 percent plunge after the Brexit vote was supposed to pave the way for a surge in the UK equities and inflation. This, indeed, is how it played out as 2017 got underway. The Federal Reserve raised interest rates twice, the dollar reached a 14-year peak, Wall Street hit record highs, and government bond yield curves around the world steepened to the benefit of banks and financial stocks.
But it is now unravelling, in large part due to a clear slowdown in the US growth and signs that global inflation is levelling off. Flatter yield curves where short- and long-term bond yields are close to each other suggest economic uncertainty. "(They) are definitely not corroborating a Trump reflation scenario. Some of the survey data is strong and has hit new multi-year highs, but the real data has been tepid," said Jonathan Tepper, co-founder of Variant Perception Research.
Citi's economic surprises indexes for most of the world's major economies have been heading south for the past month. The U.S. index has suddenly tumbled to lows not seen since November, and is below all its peers apart from Japan's. And inflation expectations are showing signs of peaking too. Estimates of first quarter U.S. growth have been slashed in recent weeks, with the Atlanta Fed's closely-watched GDPNow model pointing to just 0.5 percent compared with around 2.5 percent less than two months ago.
The US Treasury Secretary Steven Mnuchin said the Trump administration's timetable for tax reform is set to falter following setbacks in negotiations with Congress over healthcare. More than 40 percent of the fund managers surveyed by Bank of America Merrill Lynch do not expect the US tax reforms to be passed before 2018. The same survey also showed that major adjustments are taking place in key markets, and that some measures of positioning are reaching extreme levels.
Investors' exposure to the US equities is its lowest since January 2008, but their allocation to global banks is the highest on record. "Investors are scrambling out of the US equities as the majority find the US stocks overvalued and perceive a risk of delayed the US tax reform," said Michael Hartnett, chief investment strategist at BAML. Among the biggest fallers on Wall Street have been banks. They rose more than 30 percent in the three months after the U.S. election but have since drifted lower and are now down on the year.
The extreme overweight bank positioning highlighted in the BAML survey suggests there's more room to fall. A flatter yield curve is bad news for banks, who make much of their money by borrowing cheaply at the short end and lending longer term at higher rates of interest. The difference between 10-year and two-year US yields touched 100 basis points on Tuesday, the lowest since November and a far cry from 135 bps in December. And that's despite the 50 bps rise in the US interest rates since December.
"Banks don't tend to do well in a flattening yield curve environment," said Tepper at of Variant Perception Research, whose website states: "The yield curve is by far the best predictor of economic growth in most economies of the world." The dollar doesn't do well in this environment either. On Tuesday, Goldman Sachs abandoned its bullish call. Also on Tuesday, Deutsche Bank did the same with its bearish sterling forecast after British Prime Minister Theresa May's surprise announcement to call a UK general election - a "game-changer" for the pound, they said.
Copyright Reuters, 2017