Trump, the circuit breaker
Commentators can’t work Trump out but the markets are clear,
No one knows what will happen during the Trump presidency. According to US broadcaster NBC News, Donald Trump made 141 distinct shifts from his stated views over the course of his campaign. Little wonder then, that serious analysts and commentators have resorted to reading tea leaves and throwing Tarot cards to try to work out what might happen over the coming four years.
However, markets seem clear. Interest rates have risen and we are seeing a divergence of asset classes: in recent years, bonds and shares have climbed in unison, but the Trump election has seen shares go up while bond investors have been slaughtered.
For some time, bonds and shares have both been excellent investments – everyone’s been a winner. This contradicts investment theory which says bonds and shares should mostly be negatively correlated – one should rise while the other falls.
Trump’s election means that no longer is everyone a winner: shares are up and bonds are down. Negative correlation (i.e. normality) is restored.
Despite Trump’s equivocations, markets are clear the policies most likely to be implemented are big tax cuts and some major infrastructure spending.
Markets respond very quickly to news when it is unexpected: immediately the election result became apparent, shares fell. However, they quickly turned around as investors realised that tax cuts, infrastructure building programmes and a reinflating economy are good for business.
The bond market, on the other hand, noticed there is something not quite right with two likely policies: one (tax cuts) results in lower income while the other (big infrastructure projects) results in far greater expenditure. So, the big question is, how will this potentially huge deficit be funded?
Markets think the answer is that the greater deficit will be funded by debt – i.e. the US Government will have to borrow more. A lot more.
Of course, an increased borrowing programme by the US government will probably see an increase in interest rates. Bond investors will require the US Government to pay a higher rate to fund its burgeoning deficit.
In any event, the increased infrastructure spend along with consumer spending from tax cuts should see inflation pick up which drives interest rates higher as well.
And so, while shares made good gains, bond prices fell as the US 10-year Treasury interest rate went from about 1.7 to 2.2 per cent. That rise in interest rates means a sharp fall in the price of bonds because bond prices fall when interest rates rise.
After being in lockstep for years, shares and bonds are headed in separate directions again.
Perhaps Trump is the circuit
The bond market noticed there is something not quite right with two likely Trump policies.
breaker which restores investment theory again – i.e. one investment rises (shares) while the other falls (bonds).
There’s no guarantee it will be permanent, but Trump’s planned reinflation of the global economy means share investors are the winners and bond investors the losers.