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Article / 16 November 2016 at 11:30 GMT

Weekly Bond Update: Trump election ignites surprise bond yield surge

Fixed Income trader / Saxo Bank
Denmark
  • The president-elect has struck a far more conciliatory tone than expected
  • Government bond yields have risen across the curve
  • The Fed is now priced at an almost definitive 92% chance to hike rates in December
  • These markets may present a compelling opportunity for investors in the near future

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Huge surge ... bond yields soared following the US election result. Photo: iStock

By Michael Boye

Following the initial shock reaction and contrary to the preceding message from various doomsayers, the new Trump administration has been received overwhelmingly positively by financial markets so far. 

The president-elect has introduced a far more conciliatory tone, which began from the very first acceptance speech and which has replaced the irreconcilable rhetoric from the campaign trail. As a result, investors are seemingly now already discounting his promises of a growth agenda, including tax cuts, new infrastructure investments and financial deregulation, at near face value.

This combination of stronger growth confidence and rising inflation expectations on the back of debt-financed fiscal stimulus has seen developed markets' government bond yields surge dramatically in response.

In the US, Treasury yields are traded close to the year-high levels, which was last seen back in January. Government yields have risen across the curve with 10-year yields now at 2.22% and 30-year yields traded briefly above the 3% mark. 

In the shorter end of the yield curve, 2-year yields, which is a better indication of the short-term policy direction of the Federal Reserve, broke above the 1% mark – a milestone that it hasn't traded at or above consistently for several years. 

As for the Federal Reserve, it is now priced at an almost definitive 92% chance to hike its benchmark interest rate at the December policy meeting, a stunning comeback from from the sub-40% chance traders were giving this scenario during the early hours right after the upset election result.

US government yields have surged after the election of Donald Trump as the next president
TREAS
 Source: Bloomberg

Even though a case could be made for higher interest rates in the longer term under a Trump administration, this recent and rapid development is quite remarkable even given the current argument justifying the move. 

As the fiscal expansion is likely to be financed by bigger budget deficits, the Federal Reserve might still want to pursue a financial repression policy, in which interest rates are kept artificially low in order to keep borrowing costs down. This would especially be the case if it becomes less independent – as has been the widespread concern under the new president. 

As we have argued, while Trump, the candidate, might have good reason to claim that the US is a "bubble economy", Trump, the president, would have very little incentive to be the triggering factor. What's more, while the prospect of debt-fuelled inflation is a looming threat to the US economy (and a very well known one), it has arguably so far in the post-financial crisis era been a very small factor for US interest rates – if at all.

Furthermore, the suggested policies on trade barriers and immigration can hardly be said to be growth spurring, which was a major part of the reason that investors were concerned in the first place. To be fair though, we are yet to find out if these policies will be victims of the conciliatory stance as well.

Credit spreads in Brazil and Russia has widened as investors worry over USD debt exposure
BRandRUS
 















Source: Bloomberg. Create your own charts with SaxoTraderGO; click here to learn more 

Emerging markets, though, haven't been invited to the party, as the dramatic rise in interest rates and the USD has led to renewed concern about foreign debt in countries such as Russia and Brazil. As a result, the Brazil 5-year USD CDS, the price to insure 5-year USD denominated sovereign debt in Brazil, has jumped to 312 basis points from a low of 245 basis points earlier this year. 

For Russia, which is probably looking forward to a more accommodating relationship with the White House that could potentially ease the year-long sanctions against the country, there has been no relief either. The USD denominated sovereign bond with maturity in 2042 has plunged from a price of 119 to a current price level of 106. 

If history is any guidance, and if for the reasons stated above the yield rally in the US eventually reverses, these markets could present a compelling opportunity for bond investors in the near future.

– Edited by Gayle Bryant

Michael Boye is a fixed income trader at Saxo Bank

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