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Who will be the next US president? The financial markets have a bet placed firmly on one candidate
Can you predict who will win the presidential race?
The short answer is no, but some industries need to make a call on who they think will win, and plan for it.
The financial markets industry, for example, has done just that, based on where market participants believe inflation and interest rates are headed in coming years.
It’s seen significant selling in what traders call the “long end” of the yield curve.
That is, US government 10-year bond yields have been under significant selling pressure recently.
It’s a pointer to higher inflation and higher interest rates.
Why? Let’s investigate.
First debate bond sell-off
The first presidential debate bought some, well, interesting moments
Biden was heard saying to Trump, “You’re the sucker, you’re the loser,” in response to the former president mocking his son.
In another interaction, Trump commented that, “Well, I took two tests – cognitive tests – I aced them, both of them, as you know.”
But at times President Biden struggled to say anything at all, forcing words out that seemed stuck on his tongue.
He conceded this week he had “a shocker”.
Jameson Coote Bonds manages roughly $4 billion worth of fixed income or bonds.
Portfolio manager James Wilson watched the debate closely because it moved the prices of the bonds he’s trading.
He said the market sold-off immediately following the debate.
“Following the debate we saw a big sell-off in long [term bonds].”
Traders thought that Trump won the debate, which put him ahead of President Biden in the race for the White House.
The financial markets think there will be more government spending under a Trump presidency, and that will require the US government to issue, or sell, billions of dollars’ worth of new bonds.
Bond traders are essentially getting in ahead of the game here.
Think about it: if you knew, based on information today, what would almost certainly happen in the future, you would make a trade based on that information — so better get selling now then before the flood gates open.
And that will drive up bond yields or interest rates, Mr Wilson said.
“He’s looking at increasing tariffs.”
“He’s looking at increasing fiscal spend, deficits get larger, and so that means the bond yields, as a result can move higher.”
Now you don’t need to know the mechanics of the bond market here — suffice to say bond yields (interest rates) move in the opposite direction to bond prices.
But think of it this way: if huge amounts of bonds are being sold, there’s a reason for that, and it’s likely pointing to a “riskier future”, so it makes sense the interest rate or return on those bonds would go up.
It financially compensates the buyer of the bond.
Professional investor Danielle Ecuyer said the financial markets are preparing for a big ramp-up in government spending under a Trump presidency.
“That is the problem, the narrative at the moment is fiscal deficits are growing,” she said.
“How are they going to be funded?
“And how inflationary will a Trump presidency be?”
Assassination bond sell-off
But a lot has happened in the race to the White House since the first presidential debate, most notably the attempted assassination of Trump.
AMP’s head of investment strategy, Shane Oliver, said 10-year US government bonds were further sold off following the attack, pushing up their yields or interest rates.
“Bond yields just in the last day or so have gone back up again.”
The US 10-year Treasury bond is currently yielding 4.2 per cent, up from 4.18 per cent last week.
“We saw something similar after the debate, which was a bit of a debacle for the Democrats but saw Trump’s odds of winning go up,” Dr Oliver said.
“Obviously his odds of winning have gone up even further after the assassination attempt and that’s showing up to some degree in higher bond yields.”
Trump’s plans to lower taxes is seen as inflationary, and raises the prospect of higher interest rates, which would be lead to further selling of bonds, Dr Oliver said.
“The reason the bond markets are worried about it is because Trump’s policies to cut taxes or extend the tax cuts and lower tax rates even further in the US, as well as introduce tariffs, [would] add to inflation.”
“[These things] are bad news for bonds because they mean higher budget deficits in the US and potentially more inflation.
“And so the bond market, every so often, is trying to start to fact that in.”
It’s important to stress that traders have told the ABC the bond market’s reactions to major campaign moments have pointed to a Trump victory.
Subsequent rallies, or the buying of bonds, have related to other factors, including comments by the US Federal Reserve.
Critically, the yields on short-dated bonds, the ones that reflect the short-term horizon for interest rates, are falling, and long-dated bonds are spiking higher during major campaign events, which reflects a higher inflation environment under a Trump presidency.
And make no mistake, the financial markets are moving in sync with political developments.
“The events in the United States surrounding former US president and 2024 candidate Donald Trump confirm the political and economic environments are intertwined across the world in a way we haven’t seen for decades,” ANZ’s Richard Yetsenga said.
Trump Trade
Saxo’s Head of Fixed Income Strategy Althea Spinozzi calls it the “Trump Trade”.
“During Trump’s previous presidency term, the ‘Trump Trade’ led to a rally in US equities (especially in technology and financial sectors), rising Treasury yields, tightening corporate bond spreads, a stronger US dollar, and a surge in industrial metals.”
“A Trump victory in 2024 could imply that the Federal Reserve may remain cautious about cutting interest rates, as a pro-business environment might re-accelerate the US economy and increase inflation.”
It’s clear to many market participants that a Trump presidency will see more spending by consumers, businesses and government — all of which will add to aggregate, or total, demand in the economy and therefore inflation.
“The Trump Trade prompts (US) investors to increase exposure to domestic equities, favour shorter-duration bonds, implement hedging strategies against a strong USD, and diversify into safe-haven assets,” Ms Spinozzi said.
Yes, you read that correctly, the financial markets expected further all-time highs on the US stock market under a Trump presidency.
Further out, as in decades ahead, financial markets are pricing in an explosion of US debt due to a Trump presidency.
“The yield on 30-year Treasuries [this week] surpassed the rate on two-year [bonds] for the first time since January – the 30-year notes reflecting the exploding spending,” Swissquote Bank Senior Analyst Ipek Ozkardeskaya noted.
Again, the financial markets are still expecting lower interest rates later this year as inflation cools, but they see all of this being unwound if Trump sets up in the Oval Office.
A Trump presidency is expected to see higher tariffs, elevated inflation, rising interest rates, massive budget deficits and record high share prices – quite the cocktail.
The bond market is reflecting this reality now, and make no mistake there’s billions of dollars riding on it.
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