US interest rates could rise another 1% over the next 18 months if the Federal Reserve believes President-elect Trump can push through his mooted $5tr fiscal stimulus package.
Since the US presidential election on 8 November, government bonds have sold-off along with emerging market debt on expectations that Trump’s package of tax cuts and infrastructure and defence spending will lead to higher inflation and thus a less accommodative central bank.
While it is too early to tell how US Fed chair Janet Yellen will react to Trump’s win in policy terms, government bonds could see further price falls if she takes the view that Trump’s deficit-funded stimulus package will come to fruition.
There are some questions we don’t yet know the answer to. Does Yellen believe Trump will ease policy? What kind of response are we going to get from her? How long will she even be around for? We don’t know, but with full employment and some inflation pressure we think there could be another 1% on US interest rates over the next 18 months. If Yellen believes Trump will spend $5trn on policies that make a difference, then bonds have further to sell off.
Credit is likely to perform better than sovereign debt against this backdrop, although he says risks are mounting to the downside. Fundamentally we think this environment will be OK for credit,” he says. However there is a growing view that credit may be caught between more attractive risk-free assets and equities which should benefit from growth and inflation. The technicals could get nasty.
Recent market moves have benefited the team’s fixed income portfolios and should continue to present opportunities. Of course market sentiment can change very quickly but so far Trump’s win and the reaction to it has generally been good for us and overall we are starting to see prices move back toward long term fair value. Soon enough we might like the beta of our asset class.
David Roberts, head of fixed income at Kames Capital