The trinity of rising stocks, rising yields and rising dollar since Donald Trump's election has already faced a setback. Abheek Barua and Bidisha Ganguly view it as a sign of the market doubting the new US administration's ability to deliver on its pro-growth agenda.
The steep fall in United States equities after a continuous rally since Donald Trump's election is being viewed as the first signs of reversal of the Trump trade.
The 10 per cent rally since November 2016 was based on the expectation of a quick and large stimulus from the new administration, both in terms of higher spending and lower taxes. But equity markets are now sobering up as doubts have emerged over the ability of the government to deliver its pro-growth agenda.
The reflation trinity of rising stocks, rising yields and rising dollar has faced a setback.
The Trump administration has chosen to present lawmakers with healthcare reform where it lacks support rather than tax reform, which the market had been anticipating. The fear is that a possible defeat on healthcare may delay the agenda on corporate tax reduction (the bill, as we write, has been withdrawn marking a major setback to the Trump agenda).
Already, the new US president's approval rating has fallen sharply, particularly among his support base of white males without a college degree.
Involvement of his associates with Russia and the unsubstantiated allegation that his phones were wiretapped by former president Barack Obama have further damaged his credibility.
For those who did not support the Trump agenda in any case, this seems like a vindication from the markets.
Issues such as the "border adjustment" proposed by the Republicans have caused concern in terms of the damage they can do to globalisation.
In the G20 leaders' meeting held in Germany, pressure from the US side led to a retreat from the support for free trade and rejection of protectionist measures that would usually find place in the statement issued by the leaders. Instead, a toned-down version mentioned that "countries are working to strengthen the contribution of trade to their economies".
Adding to the concerns on US policy positions is the stand of the US Federal Reserve. Its "dovish" rate hike in March has left the market believing that financial conditions will continue to remain easy. This resulted in counter-intuitive market outcomes post the rate hike such as a rally in equities and a fall in the dollar, making it harder for the Fed to achieve its objective.
With the political environment turning sour, we now have a complete reversal of the Trump trade -- falling equities, falling yields and falling dollar.
What could this mean for the Fed's agenda for the rest of the year?
If indeed, the fiscal stimulus is pushed back, the Fed should be comfortable with its current projected two more rate hikes for 2017.
However, if the job market picks up further and wages continue to rise, then the Fed would be seen as "behind the curve".
Already, there are many who believe that financial conditions should have been normalised much sooner, not waiting till the recovery in the business cycle is well under way. If, at this point, the Trump agenda were to go through and provide the promised stimulus, the Fed would be caught in a difficult position, trying to ratchet up interest rates at a more rapid pace.
All this political and policy uncertainty in the US is likely to have an impact on emerging markets (EM).
At the moment, the fall in the dollar is giving EM currencies a fillip and one needn't go beyond the rupee market to see how sentiment towards the dollar has changed.
But the EM story need not have a simple linear plot. If political uncertainty in the US increases, we could see the re-emergence of "risk-off" and investors might just beat all conventional logic and seek the safety of the dollar.
Besides, revival of interest in EMs was premised at least in part of a likely spillover from strong US growth. If growth projections for America are scaled down, there could be a knock-on effect on EMs.
All this goes for the rupee as well.
However, the argument that its vulnerability to the vagaries of the global market might be limited because of its domestic market dependence and growing political stability might just hold. Thank god for small mercies.
Abheek Barua is chief economist, HDFC Bank.
Bidisha Ganguly is chief economist, CII.