Election Special: Jitters, stabilization and then?

11-09-2016

From a bond-market perspective, Donald Trump’s surprise victory can be broken down into the three stages: initial risk-off jitters, stabilization as the market’s focus returns to fundamentals, then uncertainty that could act to drive up rates and steepen the yield curve in the months to come. Here’s a brief look at each:

  • Instant reaction akin to Brexit Risk markets sold off and Treasuries rallied as Trump’s narrow electoral path became reality; currencies were affected, too, with the U.S. dollar and select emerging markets declining, particularly the Mexican peso. But fears of a Brexit-like shock have failed so far to materialize, with risk markets well off their lows as of this writing.
  • Intermediate term more about the economy We would expect after a brief period of volatility, the markets will stabilize and possibly retrace, particularly as it relates to rates and spreads. This would follow the pattern of post-Brexit market activity. This potential retracement would be driven by a return to focus on the economic fundamentals. Steady albeit moderate job growth has created a tight labor market that has resulted in the beginning of wage pressures, strengthening the case for the Federal Reserve moving closer toward policy normalization. Having said that, as the Fed factors in potential market volatility arising from Trump’s win, the probability of an expected December rate hike is less certain.
  • Longer term, it’s all about fiscal and monetary policies Taken at face value, President-elect Trump’s economic policies would appear to shift away from globalization and free trade—a move that would be potentially inflationary. Additionally, possible unfunded tax cuts coupled with accelerated infrastructure spending could deepen the budget deficit. Finally, his election provides uncertainty as to the Fed’s philosophy. Thus we would expect an increased probability of higher long-term interest rates and a steeper yield curve in the months to come.