Volatility in fixed income markets has subsided somewhat this week as the events and implications are being processed. We have more information but definitely not clarity around possible policy pathways and some people who may be executing president-elect Trump’s ‘vision’. We’ve collected some of our current thoughts on the situation.
- The combination of a Republican congress and senate increase the likelihood of a fiscal stimulus package being passed;
- Trump will be highly motivated to deliver on some of his election promises relatively early in his term – including policies around immigration, trade and regulatory policies, tax cuts, and infrastructure spending;
- At this stage the sequence of policy changes is unclear – and this matters a lot – regarding what it means for growth and inflation over the next few quarters and beyond. Infrastructure spending has a high growth multiplier, while trade barriers will restrict near-term growth;
- What we can conclude though is that the market expectations on growth and inflation are likely is to be higher than previously forecast. But there is a high degree of uncertainty around the actual policy package and whether the current fillip to optimism and wealth effects will be temporary or sustained;
- Comments from Fed Chair Janet Yellen on Thursday US time acknowledged that the package is net expansionary for fiscal policy and this will be incorporated into their policy deliberations. Indirectly, she interpreted the market’s response regarding increasing long-term interest rates by about 40 basis points and the USD by 3.5% as being appropriate. Fed Chair noted that it is all incredibly uncertain, but they will watch and react. We see no obvious impediment to a further tightening of 0.25% in Fed funds by December;
- Chair Yellen affirmed that it is ‘fully my intention to serve out that term’ that ends January 2018. Importantly, she affirmed that the independence of a central bank together with pursuit of goals established by Congress – (in the case of the Fed) was crucial. There is strong evidence that in cases of political interference the result was sub-optimal economic outcomes. In our view, affirmation of Central Bank credibility is significant for the longer term stability of markets and anchoring of inflation expectations;
- Near term, we think that bond markets will remain choppy – buffeted by announcements from the US, the flow of economic data, politics and the actions of other global central banks;
- A reminder of the latter point presented yesterday as the Bank of Japan reappeared as a buyer in the Japanese bond market – acting on their ‘yield curve control policy’ that undertakes to keep the JGB 10-year yield close to zero;
- A theme of divergence in global central bank policy is one certainty, and an emergent theme is the degree to which fiscal policy will feature as part of the mix with the US leading the way;
- Within our portfolios, post the Trump election, they have benefited from a range of bearish US interest rate strategies and expectations for higher market pricing of inflation and steeper yield curves. We have taken profits on most of these positions following the significant market moves with a view to re-entering these types of strategies as markets move back towards more attractive levels.
Written by Anne Anderson, Head of Fixed Income, UBS Australia: (VIEW LINK)
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