It’s not a State of the Union address, but Donald Trump’s speech at a joint session of Congress on Tuesday night is going to be closely watched by investors for more details about policy direction and how this will influence everything from equity prices to bond markets.

Markets have been betting big that the so-called Trump trade – lower taxes, higher spending – will deliver a boost to US economic growth, corporate earnings and inflation. We ought to know a bit more about the details after the address, although no one is expecting all the fine print to be explained.

Tax

 

The biggest thing on the agenda is possible tax reform. There are two parts to this – lower corporate taxation, and the possible introduction of a border adjustment tax.

Trump has indicated he will slash corporate taxation but the details have been very hazy. Markets will be looking for a clearer picture, but could be disappointed if there is still no detail.

The Dow Jones industrial average has notched up 12 straight record closes as bullishness around Trump’s policies becomes ingrained.

WallSt_Feb28th

The central support for this rally is the belief that corporate earnings will rise off the back of lower taxation and firmer growth. Small-caps pay more corporate tax than multinationals so any cuts should benefit these firms. The Russell 2000 is the best barometer for these stocks and it too has shown impressive growth since Trump’s election.

Russ2000_Feb28th

If we get details about the border adjustment tax, there may be individual sectors that suffer. This tax, which is essentially a tax on imports, is seen as being bad for carmakers and the big retailers, although it is unlikely he will delve down into the details of this policy in his speech.

Also watch for anything on interest deductibility on borrowing, which could hit highly leveraged companies.

Growth

 

On the bond front, US paper has been fairly steady ahead of the speech, with the 10-year Treasury note trading around 2.4%. Interest rates are expected to rise only gradually, while reforms if they come may face obstacles in Washington. The Trump trade has yet to encounter any serious opposition but investors seem to think that the kind of explosive growth – which would require the Fed to raise rates a lot quicker than currently anticipated – is unlikely. The speech to Congress has the potential to alter this view or confirm it, meaning there is likely to be a fair bit of volatility in US government bonds.

Obamacare

 

We expect Trump to tackle the Affordable Care Act – Obamacare - in his speech. Dismantling this was a core part of his pitch to voters and comments around this area are expected to impact health insurers.

Spending

 

Caterpillar and Chevron led the gains on Monday as the Dow rallied again. It's no coincidence these might be some of the stocks expected to benefit from higher infrastructure spending. A reiteration of Trump’s commitment to build his Mexican wall is likely. But this is just one part of the picture – big spending increases for roads, bridges and other large infrastructure projects are part of the president’s programme.

Ahead of the speech Trump made a commitment to boost defence spending by $54bn a year, which produced a rally for defence stocks.

Trade

 

Markets have so far overlooked some of the less pro-growth trade policies on offer from Trump. Comments from cabinet members may be softening the language but we might be in for a rude awakening if Trump uses this speech to outline protectionist policies, such as circumventing WTO rules or labelling China a currency manipulator. The most appealing strategy to trade this part of the speech is more likely to be in currency and bond markets rather than equities as the dollar and emerging market currencies and debt could be very sensitive to the speech. A protectionist message might roil currencies like the Mexican peso. The char below highlights how MXN has come back since diving after the election in November.

Coupled to trade is the relative strength of the dollar. We may also see Trump dial down on the dollar strength and attempt to talk it down – something he has tried on occasions in the past.

USDMXN_Feb28th

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