Some bond investors are looking to take advantage of market volatility since Donald Trump's re-election as U.S. president.Nimito/iStockPhoto / Getty Images
As Donald Trump prepares his return to the White House, bond investors are speculating about how campaign promises will play out and the effect they’ll have on inflation and markets.
Whether the president-elect begins his presidency with sweeping tariffs and a clampdown on immigration or whether the changes will be more gradual – or whether they’ll happen at all – will affect the path of inflation and the economy.
“There was a lot of expectation that things would settle once we at least knew the results. Those expectations were geared toward a [Kamala] Harris victory,” says Gennadiy Goldberg, head of U.S. rates strategy at TD Securities in New York.
“At this point, everything’s still up in the air,” he adds. “You have a very wide range of possibilities in terms of what Trump can do in a second term. Every investor has a significantly different view on what they think Trump has been saying and [what] Trump will do.”
It’s also a question of magnitude, explains Mr. Goldberg, and Mr. Trump’s vow this week to impose 25-per-cent tariffs on all products from Canada and Mexico as soon as he takes office shows how extreme and swift the incoming president’s policies may be.
“You’re not sure right now what is policy and what is a negotiating stance, only then to be revised later,” Mr. Goldberg explains. “It’s interesting that the announcement was made even before the administration took office. Perhaps that’s putting trading partners on notice that the new administration is going to expect very fast results, so it does suggest there is a negotiation coming.”
Based on Mr. Trump’s last term, many bond strategists appear to have pencilled in higher fiscal deficits, but Mr. Goldberg says the market is experiencing a lot of “whiplash” right now as it reacts to the odds there may be some benefits alongside the disruption.
“If we get tariffs, do we also get tax cuts? If we get higher fiscal spending, does that help boost growth or not? There are all sorts of questions,” he says.
That’s led to volatility, “because the market doesn’t fully know which way the Fed’s going to move, given this overarching uncertainty,” he adds.
The U.S. Federal Reserve Board cut interest rates by a quarter of a percentage point in its first decision after Mr. Trump’s election, but many consider the rate-cutting path to be less clear given the incoming president’s policy proposals.
The weeks since the Nov. 5 election have seen the yield on 10-year U.S. Treasuries spike to almost 4.5 per cent on a few occasions.
Mr. Goldberg says many investors are likely playing it safe to close out the year. “Some investors are trying to wait until we get more settled on the outlook and then try to reassess as we get into next year.”
So-called “bond vigilantes” who sell their bonds as a response to fiscal measures (often inflationary) they don’t agree with have also been a concern since the election. The US$36-trillion national debt means any spending these bondholders consider to be irresponsible could see them selling or, at the very least, demanding a higher risk premium to hold government bonds.
The U.K. Labour government felt the brunt of unhappy bondholders following the release of its budget last month, with plans for increased spending and a higher deficit. The sell-off that ensued spiked yields on the 10-year government gilt to 4.57 per cent, the highest level in more than a year.
Earl Davis, head of fixed income and money markets at BMO Global Asset Management in Toronto, says uncertainty around inflation creates the right environment for bond vigilantes. “The more uncertainty you have, the more risk premium you want because you want to earn above expectations.”
He says there are two things to consider when looking at the outlook for bonds: the destination, meaning higher or lower yields; and the path.
“There’s more certainty in the destination for me, and that’s higher bond yields. There’s more volatility in the path,” Mr. Davis says, and that creates opportunities for active managers. “Once you know it’s going to be volatile, you could monetize that.”
Investors retain vivid memories of what the previous Trump administration was like, but it’s still difficult to predict policy, says Darcy Briggs, senior vice-president and portfolio manager with Franklin Templeton Investment’s fixed income team in Calgary.
“Where things get inflationary is if we end up with a tariff war,” he says, and “that’s where the bond vigilantes will step in, too.”
Mr. Briggs says without a crystal ball, everything is mere speculation at this point and we’ll have to wait until Mr. Trump takes office in January to see how it all shakes out.
“There are so many moving parts [that] to get it calibrated right, before anything’s been announced, is impossible.”