Prepare for Emperor Trump’s US treasury bear market


It wouldn’t do to begin this column in 2017 by gloating, although I felt I might congratulate myself at the start of a new year by reminding readers that the right call was made here on the biggest market event of 2016 and one that will unavoidably shape markets in the coming years: the victory in the US presidential election of Donald Trump.

And it’s as well to remind ourselves of just how far market psychology has transmogrified since that event. We have gone from the phenomenon of negative yields in some of the world’s biggest government bond markets, including those of Japan and Germany, and the looming fear of “Japanisation”  in developed and emerging economies - rooted in low growth and deflation - to a yield reversal encompassed in the belief that Mr Trump will reflate the US economy.

I am inclined to go along with this new psychology and its attendant belief that the 35-year bull market in US treasury bonds is over. The question for asset managers is how this manifests itself - will it emerge in measured form, as it has done so far, or will it make its appearance in the context of panic and the most painful debt market unwind of all time?

Back in the mid 80s when I worked in the bond markets as an institutional fixed income salesman, the treasury market tone was set once a month by the release of US trade data. But by the end of the decade, non-farm payroll data had replaced them, and that remains the case today.

I suspect we will have to get used to policy statements on the topics of infrastructure spending and budget deficit financing from Mr Trump’s administration as more significant treasury market movers than just employment data. Add into the mix any hints of protectionism and the start of a trade war with China and you get the new market-moving order for US treasuries.

I have little doubt that Mr Trump’s presidency will be marked by the grandiose in terms of infrastructure spending along the lines of Imperial Rome - emperor would seem to be the self-image he has already assumed as president-elect - and that he will utilise debt in numerous forms to achieve his imperial ambitions.

There is already talk of opening up the ultra-long point on the treasury curve, with issuance of 50 or 100-year bonds. And the debt ceiling will have to be pushed up in March, with the burning question being by just how much. Republican control of the House and Senate will allow this to go smoothly, but the real question will be whether Mr Trump, who styles himself as the “master of debt” will open the floodgates for a debt explosion and whether - more worryingly - this epithet, which has its origins in Trump’s long experience of debt restructuring and playing hardball with creditors, will cause a bond market panic.

In that scenario Asian bond markets will present something of a safe-haven and I would be looking to spread up some regional long end government paper versus a duration-weighted Treasury short. That we are in the midst of the calm before the storm seems the right call. Enjoy the fortnight before Mr Trump’s inauguration and get ready for the volatility, led by the downside in US Treasury bond prices, once he assumes office.