Investors used to low rates may be about to get Trumped.
Since the credit crisis, interest rates have consistently moved lower due to quantitative easing and central bank intervention. Trillions of dollars have been pumped into the financial system instead of the real economy. By using the money to deleverage banks, we in turn muted inflation and helped interest rates remain low.
In order to 'make America great again,' we're going to have to return to real interest rates. That spells a terrible bond market.
We've already seen this since the election. A 60 bps increase in 10-Year Treasuries may not seem like much, but for near-zero treasury yields, that's an increase of 32 percent since November 8.
The Donald Trump that took on the Republican establishment to win the nomination and then the Democratic establishment to win the presidency is nearly impossible to predict. His victory has been so disruptive precisely because of his unpredictability. Without a long political track record to go off of, all we have is a spate of campaign promises to analyze.
But if he makes good on making America great, the bond market might be selling off big time.
He says he intends to:
- Cut taxes across the board. That could mean less revenue for the government. It may also mean more money in consumer's pockets, more discretionary spending and, in turn, inflation.
- Spend trillions of dollars on rebuilding America's infrastructure. This could create massive job growth as money is injected almost directly into the economy. Wage inflation would put upward pressure on cars, housing, food and other consumer staples. This would push prices higher, which could mean – no surprise here – more inflation.
- Repeal and replace Obamacare. Lower premiums would cost insurance companies money, but benefit consumers since they may have more discretionary money to spend.
- Reduce regulation. A "pro-business" stance should allow for more business activity which could lead to more wage inflation and therefore more real inflation.
- Demand more pro-U.S. trade deals. Reducing the amount of imports into the U.S due to cost effectiveness would restrict supply in the marketplace. A mixture of less supply with similar demand begs for higher prices, and therefore (see a potential pattern here?), more inflation.
- Reform U.S. immigration policy. This threatens to restrict access to lower cost workers, which will in turn create higher costs for businesses due to wage pressure.
Just by getting elected, Trump has done what the Federal Reserve has been trying to do for years with quantitative easing: steepen the yield curve. When the yield curve steepens, it makes banks more willing to lend money. Those loans are another direct injection of money into the real economy.
That potential injection, mixed with the promises of deregulation and more "pro-business" policy, should be an indication that there will, in turn, be less quantitative easing.
But therein lies the rub – every point that interest rates rise is another jump in the billions of dollars the U.S. will have to pay back in interest. Because even 1 percent is a lot when it's 1 percent of $20 trillion. With these latest moves, though, the Fed has little choice but to inch rates higher 1) because they can and 2) the Fed knows it needs to raise rates now so there is somewhere to go if cuts need to be made during the next recession.
Any way forward for bonds will be tough because negative rates have crowded investors into bond types with creeping correlations. Even keeping the status quo would still leave everyone dissatisfied. This path is the one of increasing inflation and yields, and is therefore the most painful for bond investors.
But Trump's proposed path could also be the way toward higher interest rates for savers and retirement investors, toward potential job growth in rural and corporate America, and possibly inflation without succumbing to stagflation.
Or maybe we're all Trumped. That's only something time will tell.