The post-crisis environment in the rich world has been marked by deflationary pressures and an unprecedented demand for debt – what more and more observers are calling a bond bubble. A week ago, there seemed to be little end in sight. Then Donald Trump won the U.S. presidential election. Judging by market reactions since Trump’s victory early Wednesday morning, inflation expectations are rising, and bond yields are climbing as investors price in the new reality.
Factors the markets must now consider include Trump’s promises for fiscal stimulus, his mostly-consistent hostility to monetary stimulus, his potential to empower like-minded figures in other rich-world democracies, and his reputation as a risk-taker.
NOTE: Trump’s impact on the economy is a thoroughly dense topic. This post discusses some aspects of why the market is reacting to Trump’s election, along with one of the more interesting effects (the popping of the bond bubble).
The election of Donald J. Trump has had a substantial impact on the world economy. One example is the “Great November Rotation”, an all-encompassing description of fund flows seen during the month, that resulted from the widespread belief that the actions of president-elect Trump will spur inflation. The expected inflationary atmosphere is largely based on the belief that Trump will ramp up a pretty tasty deficit while in office. Below are some of the positions/ideas attributed to Trump that have the markets behaving in this manner:
- Heavy infrastructure investment
- Widespread tax cuts
- Tighter immigration methods (border wall, deportations)
- Protectionist policies (higher import prices, etc.)
- Repay less than the full amount that the US has borrowed from overseas
- direct quote: “I would borrow, knowing that if the economy crashed, you could make a deal.”
- Bring other like-minded “rich-world populists” (read: protectionist / conservative) into the fold like Marie Le Pen in France
- All previously mentioned reasons make US debt riskier (despite the fact that the risk of default is still negligible, we are still America)
These speculations are not baseless. The market fluctuations are firmly grounded on comments the president-elect made during his campaign. The Committee for a Responsible Federal Budget (CRFB) estimated in September that Trump’s policies would push the American federal debt to 86% of GDP, up from 77% today.
The speculation of Trump-influenced inflation, “Trumpflation” as its being called, has had effects like the puncture of the bond bubble. This bubble had developed in the wake of the financial crisis due to fiscal austerity (our government stopped spending to ameliorate the woes after taxpayer-funded bailouts proved not-so popular) combined with the Fed’s policy of quantitative easing (near-zero interest rates combined with systematically buying bonds, w/ newly printed money, to try and stimulate the economy). These policies helped to fuel a deflationary environment where the real value of debt increased, a less than ideal situation when coupled with the Fed’s whole QE schtick (aka accruing debt). I should note that these policies were congruent with other deflationary amplifiers like stronger trade links between countries and technological developments that depressed prices, along with an aging population that tended to save (and vote for Trump, coincidentally). Most investors became content piling up cash because it was so cheap to do so. This excess liquidity led to over-investment in American debt because the Fed was always buying them, driving their prices higher than their intrinsic value. However, after the victory of Trump, investors are selling their bonds and moving large portions of that money into areas like commodities along with TIPS (Treasury Inflation Protected Securities, just google them). These shifts further demonstrate that the market is predicting inflation on the horizon. Now, the degree to which the president-elect will follow through on any/all of these policies remains to be seen. Trump could very well pull back from a lot of these stances and I would not be the least surprised. The fact that Trump has not even spent a single day as President of the United States is almost laughable with all the speculation that is going on. The market will be capricious on the road ahead.
P.S. Get used to “Trump-(insert economic/political/social issue)” terms getting thrown around way too often. Another overused “…-gate” that no one asked for.