November 11, 2016

Making Yields Great Again: Trump Unleashes A "Bigly Rates Repricing"

The details which explain why DB, which until recently was very bullish on fixed income, is now bearish on fixed income and thinks that "Trump’s victory cements the shift in the policy mix", are as follows:

Trump’s victory is fundamentally bearish fixed income from a pure economics perspective. The key risk to the view comes from increased geopolitical uncertainty.

If Trump’s economic program is taken at face value, it would imply (1) increased fiscal spending, (2) reduced regulation, (3) a change of Fed leadership and (4) increased protectionism. Each one of these factors is bearish rates.

First, as we highlighted last week, Trump’s plan is consistent with more than 2.5% of GDP of annual fiscal stimulus over the next ten years (see table below). Of course, the extent to which the plan will be implemented is unclear. However, Trump is arguably in a strong position relative to the Republican Party and the latter controls both the House and the Senate. This should give Trump leverage to implement his fiscal plan, at least initially. Also, one of the clear statements made by Trump in his acceptance speech was that he intends to significantly increase infrastructure spending. It is worth noting that the Fed in principle welcomes more fiscal support as it sees the US economy as being constrained by a lack of demand. Given that the fiscal stimulus will occur as the US economy is close to full employment, it should have a faster spillover on monetary policy, notwithstanding the desire from the current Fed leadership to run the economy hot. Increased fiscal spending should be supportive of higher yields from a macro perspective (supports domestic demand and inflation) and from a flow perspective (reduces the supply/demand imbalance).

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