Bond Market's November Surprise
American bond buyers have followed a fairly straightforward set of investing rules in recent years. It took just a few weeks for those principles to be upended.
Before the election of Donald Trump as the next U.S. president, these basic guidelines included: don’t fight central bankers and their all-powerful monetary policies. Don’t expect a sudden surge in inflation. And count on ultra-low bond yields in Europe and Japan to continue pushing money out of those places and into the U.S.
In less than a month, it seems as if everyone's ideas have changed. Now, investors are steadily increasing their inflation expectations. This is perhaps because Trump has talked about big infrastructure spending programs and negotiating new trade deals, both of which may lead to products being more expensive for U.S. consumers.
Meanwhile, Federal Reserve policies have suddenly fallen into the background. There's more speculation about what the central bank would look like under Trump than when central bankers will raise rates. In fact, traders are pricing in a 100 percent chance of a Fed rate increase in December, with talk of how quickly benchmarks may rise next year.
U.S. benchmark rates surged, even as European yields remained low. There were signs that some foreign investors were withdrawing cash from dollar-denominated government bonds even as the debt offered some of the biggest premiums relative to German debt in more than a decade.
This divergence is notable and raises several questions. Will U.S. policies and the subsequent selloff in Treasuries force bond yields higher around the world? Or will the gap widen further, strengthening the dollar even more?
The sudden change in mood highlights how quickly markets can change, undermining consensus beliefs. While there have been material changes to the general bond-market outlook since Trump was elected, investors could be soon forced to challenge even these newest assumptions.
Expectations for Trump's fiscal stimulus are already being tempered. Fed officials are largely taking a wait-and-see approach before committing to a faster pace of rate increases, citing continuing slow growth in the world's biggest economy. And Europe is facing its own political challenges that may overwhelm what its central bankers are doing to suppress borrowing costs.
Regardless of whether the abrupt shift in bond-market rules becomes the new normal, the old regime seems to be over. Investors are no longer tied to the hip of central bankers. While many bond buyers will welcome this development, they will also find it difficult to anticipate the inevitable sharp turns ahead.
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