Market’s Trump trades at risk from bond vigilantes
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Francesco Guerrera
LONDON, Nov 20 (Reuters Breakingviews) -Markets have experienced a “Trump bump”. The euphoria among equity investors, cryptocurrency fans and dollar-loving currency traders stems from U.S. President-elect Donald Trump’s deregulation and tax-cut pledges. But running such a hot economy would also make the deficit and inflation soar, unsettling debt markets. Bond investors could make America small again.
In the end, it was the inflation rate, stupid. The famous quip by Bill Clinton strategist James Carville about the economy’s importance in U.S. presidential elections has been rewritten by Trump’s triumph. Despite presiding over strong growth and low unemployment – and a fall in the pace of inflation – voters penalised the incumbent Democratic Party because of the steep rise in the cost of living.
U.S. consumer prices are 21% higher now than when outgoing President Joe Biden won the previous election in 2020, official data shows. In the 10 key states that sent Trump back to Pennsylvania Avenue, three out of four voters said inflation had caused them moderate or severe hardship over the past year, according to exit polls by NBC. Most of them also said they voted Republican on Nov. 5.
Ironically, Trump’s stated policies are likely to stoke inflation. That’s particularly true for his pledge to slap 10% tariffs on all imports, as well as 60% levies on China-made goods. An increase of that magnitude would raise the effective duty on U.S. imports from 2% now to around 17%, according to Dario Perkins at TS Lombard, which would be a post-1940s peak. That, in turn, would add 1.3 percentage points to the consumer price index, equivalent to a 20% spike in oil prices, he calculates. To put that in context, CPI rose at an annual rate of 2.6% in October, already above the Federal Reserve’s 2% target.
Equity investors don’t seem overly worried: the benchmark S&P 500 Index soared after Trump’s victory. It has dipped since but remains above its pre-election level. As befits an age where different portions of society believe separate and conflicting narratives, the financial community is hearing what it wants to hear from Trump – namely, the president-elect’s promise to deregulate vast swaths of industry, with the help of private-sector allies like Tesla’s TSLA.O Elon Musk. The belief that these policies might unleash a mergers and acquisitions boom has boosted the stock of investment-banking boutiques like Moelis MC.N and PJT Partners PJT.N, whose shares are up about 10% since Nov. 5.
Fund managers also like Trump’s idea of cutting corporation tax to 15% from 21%, which seems more plausible now that the Republicans control both houses of Congress. That would add 4% to the average company’s earnings per share, according to Goldman Sachs. Traders have even found a silver lining in the prospect of trade wars. The Russell 2000 Index of small-capitalisation stocks briefly outperformed the S&P 500, partly because investors believed that protectionism would help domestically focused firms.
At the other end of the Trump trade spectrum, bitcoin has risen by more than a third since Nov. 5, on the back of the new president’s promise of making the United States the “crypto capital of the planet”. The euphoria of so-called “risk assets” like stocks and digital currencies is understandable. A fiscal loosening, coupled with ongoing Federal Reserve rate cuts and deregulation, is likely to add to already-heady economic growth rates. The International Monetary Fund expects U.S. GDP to expand by 2.8% this year and 2.2% in 2025, which is much faster than in many other Western countries.
But there will be costs, mostly borne by the public coffers. Trump’s policies could add up to $15.5 trillion to the country’s budget deficit in the next decade, according to the non-partisan Committee for a Responsible Federal Budget. Since the deficit already exceeds 7% of GDP, such a fiscal splurge could call into question the sustainability of Uncle Sam’s finances.
Bond markets have noticed. The yield on 10-year U.S. government debt has risen from 3.6% in September to around 4.4% for two reasons: fears that the Fed will have to keep interest rates higher than otherwise due a Trump-led inflation resurgence; and investors’ desire to be paid more to compensate for the risk of higher debt levels.
The optimists argue that the Treasuries can withstand such shocks without collapsing in the way that UK gilts did in 2022 after a package of unfunded tax cuts by then-Prime Minister Liz Truss. The dollar is the preeminent global currency, ensuring strong foreign demand for U.S. assets such as government bonds, or so the argument goes.
The problem is that rising bond yields undermine the case for owning equities even if Trumponomics is less devastating than Trussonomics. Higher returns on bonds, which are a safer asset than stocks if held to maturity, can lure investors away from equities. That’s especially true if, as is the case now, key benchmarks like the S&P 500 trade at high valuations. Another problem for stocks is that higher bond yields imply chunkier discount rates for far-off cash flows, reducing the present value of equities.
Of course, the famously voluble tycoon could renege on his campaign promises once in the White House or dial them down if he sees that the economy and markets are taking it badly. But if he sticks to the script, the next leg of the Trump trade may be to go short everything that’s been rising so far.
Follow @guerreraf72 on X
Graphic: US prices have risen sharply since Joe Biden’s election https://reut.rs/4fxeK3W
Graphic: US small-cap stocks surged after Trump’s victory https://reut.rs/3UXoIU0
Editing by Liam Proud and Oliver Taslic
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