Sometimes the market narratives just write themselves.
US assets dropped sharply on Wednesday, with the widely-followed Dow Jones Industrial Average shedding a (relatively) massive 370 points and the dollar index dropping to its lowest level since the US election. The CBOE Volatility Index, the widely-cited "fear index", spiked nearly 50% on the day (For more on the market reaction, see "'Teflon Don' faces another test as USD/JPY crashes through key levels" by my colleague Jamie Dutta).
The "obvious" culprit was the news that former FBI Director Comey's memos allegedly revealed that President Trump asked him to drop the investigation into former National Security Advisor Michael Flynn. For those international readers who haven't been closely following the day-by-day US political drama, the concern is that this information, if true, represents a possible impeachable offense for the President. At this point, any sort of impeachment is highly unlikely, but prospects of imminent health care or tax reform are rapidly fading as the White House scrambles from crisis to crisis.
We don't deny that the increasing political risk represents a headwind for US assets, but the second-level impacts may be even more important for traders. Specifically, the prospects of aggressive tightening from the Federal Reserve have started to fade.
While US central bank policymakers continue to stubbornly imply that they plan on raising interest rates at least twice more this year, the US economy has been anything but strong of late. A few weeks ago, we learned that the US economy grew by a meager 0.7% annualized in Q1. This month's top-tier data releases, including retail sales and CPI figures, have also disappointed, though it is worth nothing that the jobs report at the start of the month did come in better than expected.
Barring a disastrous May employment report, the Fed still appears likely to hike rates at its June meeting. According to the CME's FedWatch tool, Fed Funds futures traders are pricing in about a 75% chance of rates rising, a probability that has actually risen marginally from last week. That said, the market-implied odds of three rate hikes by the end of the year have ticked down to just 10%, despite support from some of the more hawkish Fed members and economists still support.
Source: CME FedWatch
Looking ahead, political revelations, crises, and scandals will continue to dominate the headlines in the months and weeks to come. But when it comes to trading and investing, readers continue to tune out the "noise" and focus on the signals that markets are giving.