Markets have responded as expected to Donald Trump’s victory – higher Treasury bond yields, firmer equities, and a stronger dollar. It is a re-run of 2016. In 2016, 10-year Treasury yields bottomed in July and rose 50 basis points (bp) before the election. They shot up another 85bp in the month or so after the election, reaching 2.65% from 1.80% on the day of the vote. After that they traded sideways to lower, until rising again in late 2017 to November 2018, peaking at 3.20%. On a net basis from the low below the election to the peak two years after Trump’s victory, yields rose by 180bp.
This year yields bottomed in September and had already risen 62bp by election day. If the pattern of 2016 is to be repeated, then we could be looking at yields continuing to increase another 100bp or so over the next year or two, giving a nominal yield of around 5.5%. However, the pattern of 2016 saw yields not really move that much higher after the initial post-election jump. Between the end of November 2016 and November 2017, the ICE BofA US Treasury index’s total return was +2.0%. Yields actually fell for part of that period.
Again, the fundamental story would be Trump’s supposed preference for policies that would be fiscally expansionary and inflationary and whether this will prevent the Federal Reserve (Fed) from cutting interest rates as much as the market had hoped. Growth is arguably above trend, inflation is still above target, and so the Fed might need to keep rates on the tighter side of neutral for longer.
In 2016 to 2018 the Fed was tightening monetary policy. That helped send bond yields higher. Yields peaked in November 2018; the Fed Funds Rate peaked in December. The Fed tightened by 200bp; bond yields rose by 180bp. In 2024, the Fed is easing, and we do expect more easing. That may limit the extent to which yields will rise. Also, real yields are much higher today, which also may strengthen the argument that yields will not need to rise as much. In fact, real yields are high across the curve given the decline in inflation. Any higher and they will start to raise the likelihood of a hard landing.
Also read: ESG and EM Under a New President
How the market eventually trades depends on initial sentiment (reflation, higher rates and equities, stronger dollar); actual policy decisions (we won’t know until January at the earliest what the Trump Administration can actually do and whether the president will go all in on tax cuts and import tariffs); and the behaviour of consumers and businesses towards the proposed policies and how it impacts their spending, pricing behaviour and wage demands. Real yields are getting close to levels suggested by real GDP growth. There may also be a fiscal risk premium embedded in longer-term yields. They are relatively higher by recent standards. Equities (currently expensive) have gone up in price; bonds (fair value to cheap) have gone down in price. Policy uncertainty puts risky assets more at risk.
