In the hours after Donald Trump's startling upset in the U.S. presidential election, the reaction in the bond market was surprisingly muted.
While traders initially piled into benchmark U.S. Treasuries to hide out from turmoil, they were already reversing that bet by the New York morning. Even riskier credit markets that were initially punished were starting to bounce back. Markets seemed slightly rattled but taking a Trump presidency in stride.
So does that mean that investors with billions of dollars on the line believe that Trump will at least preserve the status quo when he takes office if not ignite some long-desired, productive inflation?
Unfortunately, it's not so simple to get a clear message from bond markets that once provided deep insight into the broader economic outlook. After years of unprecedented monetary policies that have pushed benchmark borrowing costs to record lows, it's hard to determine what's safe and what's risky in debt markets, let alone how an untested, unconventional president will influence the new balance.
The knee-jerk response in the face of uncertainty is to pile into benchmark government debt, but in this case, that may be exactly the wrong move. Trump is widely expected to borrow more money to build things, which may spur growth, or at least inflation. That could be good for stocks and riskier debt but bad for Treasuries.
But all growth is not the same. If Trump borrows too much too quickly, it could lead consumer prices to increase without wages going along for the ride, meaning that consumers would just be able to buy less. Also, the U.S. dollar would probably depreciate against rival currencies, leading to higher prices on imported goods. This is the dreaded stagflation scenario, which HSBC now sees as a real possibility.
So in that case, risk assets wouldn't do well at all, but neither would government bonds that now pay historically low yields. Neither would cash because it would be worth less and less as consumer prices rose. Gold would be the main beneficiary, and certainly that metal is seeing a pop. There's also a scenario in which deficit spending will crimp growth in the long run, leading to slower economic expansion and less inflation.
For now, investors are somewhat paralyzed in a sea of "what if" conjecture without a clear sense of what Trump wants, or will be able, to do. But that doesn't mean they are staying on the sidelines, either. The amount of overnight trading was four times the tumult seen in Treasury futures after Britain voted to exit the European Union in June, according to Jim Vogel, an interest-rate strategist at FTN Financial. Investors are looking to act. The appearance of bond-market calm is a lack of understanding about what the next president will unleash, not a sense of complacency about the future.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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