Yields Jump on “Trump Thump”

18/11/2016 at 5:23 pm

The election of Donald Trump to the US presidency apparently “wiped out more than $1 trillion across global bond markets“, as reported by Reuters earlier in the week. The inflationary nature of his policies has not, after all, gone unnoticed. Bond markets have digested new information and responded rationally, by falling in price so as to offer investors the prospect of higher real returns. Yes, the politics have tinged the reporting – as with the economic consequences of the UK’s decision to leave the EU. But surely the picture is clear: an event has occurred, markets have responded efficiently and their response is cause for concern.

As in the case of Brexit, however, the political element seems to have cost some observers their perspective. Starting with the obvious: only part of that $1trn comes from the US itself. And bond markets have been weakening for some time: Mr Trump’s election only accelerated the process. Referring to the BofA Merrill Lynch US Treasury Index, the full market value of US government bonds climbed to a peak of $9,729bn on the 8th of July, when the ten year bond yield reached a record low of 1.36%. By 8 November, before there was any indication of the surprise election result, this value had already fallen to $9,507bn. As of yesterday, the number was $9,296bn. So most of the fall since the summer preceded the new president entirely.

More broadly the invocation of a “Trump thump” is a symptom of the behavioural concept known as anchoring. We had become very used to both the recent level of bond yields and the pace of their rise before the election, so the sudden change shocked us into thinking that something anomalous had occurred: in this case, a dramatic change in policy direction arising from the victory of a candidate from left field.

This is at best a partially misleading analysis. Inflationary pressure has been mounting – and disinflationary forces have been receding – for some time. Look at the prices of base metals and freight and global activity seems to have been picking up over the second half of this year too. What is strange – perhaps – is that bond yields remained at record lows for such a long time. Putting it unkindly, bond markets have often seemed to care much more about the last ten weeks than the next ten years. There is a case to be made that the so-called “thump” was no more than a catalyst to their ongoing recovery from inertia.

Time for some more context. Yes, the US 30-year yield has risen by its fastest pace since at least 2009, putting on 40bp in four trading sessions starting last Wednesday week. But it has since spent the whole of this week hovering around the 3% mark. The initial spike was unusually volatile, but taking a slightly longer view the 30-year yield has now risen by about 1% in total since its July low – and did exactly the same thing over a similar period in H1 2015.

Look at current pricing in absolute terms and 3% is not even a high number. Trump has only managed to thump the 30-year Treasury yield back up to where it ended last year. It is almost exactly in line with its five-year average. And this is still miles below the 5.3% it posted on the cusp of the credit crunch (21 July 2007).

From another angle, a 3% return for thirty years looks plausible in real terms if we focus on the most recent American CPI data (last in at +1.6%). But long run expectations according to the University of Michigan survey are closer to +3%, and the 21st-century average prior to the Great Recession was +2.8%. On that basis the election result has only delivered US investors a prospective 30-year real return of 0.0-0.2%. In fact if one really wanted to get bearish on bonds one might observe that these levels of inflation would, not so very long ago, have been regarded as unachievably benign in any kind of growth-positive environment for the US economy. That is why the bond market has been able to rally to new highs year, after year, after year since inflation peaked at 15% in 1980.

So from a politically detached perspective, perhaps we should forget about Mr Trump’s impact on the US bond market. Fundamentally speaking he has taken the stage as accomplice, not assassin.

What we oughtn’t to do, of course, is forget about the possible impact of bond markets . . .

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