Market Memo: When it comes to yields, the times they are a changing

11-17-2016

In the 1½ days since it became apparent Donald Trump would be the nation’s 45th president, the 10-year U.S. Treasury yield has jumped from as low as 1.72% at 10:26 p.m. on election night to 2.09% as of late Thursday morning, some 36 hours later. The trend lines suggest this spike in yields may still have some legs.

The spike in yields is happening because Republicans held both the House and the Senate, virtually guaranteeing the relatively rapid passage of a fiscal stimulus package that was a part of Trump’s economic agenda. It’s likely to come in the form of some combination of infrastructure and defense spending coupled with personal and corporate tax cuts as well as a possible repatriation tax holiday for corporate profits earned overseas.

This fiscal punch would come as inflation metrics already are rising domestically and around the globe, driven by a combination of wage gains and base effects associated with the bounce in oil from its low of $26 earlier this year to around $45 today. After printing negative trends for the better part of 4 years, producer prices in China also have turned positive year-over-year. China, as much if not more than Brexit and Europe, has been the source of the disinflationary if not deflationary scare that drove global yields so low this year.

We still think the Fed will tighten in early December—the market currently is assigning an 82% probability of that happening—but will remain very measured in the pace of its rate increases given its desire to let the economy run hot. We also think the yield curve has further room to steepen. If there is fiscal stimulus against the backdrop of a gradual Fed, bond investors will have to be compensated for inflation risks with higher yields for long-dated maturities.

Last week our duration committee shortened duration from 97.5% to 95% of neutral in our fixed-income portfolio model; this week, it lowered duration again to 90%. Until the market can assess the inflationary consequences of policy changes to be implemented by the Trump administration, uncertainty is likely to push yields higher.