In the nine days since the election Trump has already achieved something. He’s persuaded the financial markets to put their money to work.
What do I mean by that? Well since 2009 the markets have been in a sour mood. They haven’t expected much economic growth.
That’s a problem. The markets don’t just reflect reality, they create it. When people expect a slow economy they don’t spend or invest their money, which in turn causes a slow economy. It’s a vicious circle.
That’s why central bankers and politicians try to stimulate the economy. They want to break the cycle. In America, they’ve been trying to break the cycle for seven and a half years.
Obama went first. In February 2009 he convinced Congress to spend an extra $900 billion to kick-start the economy. A month later the Fed started its QE (aka money-printing) programme. There was QE1 in 2009, QE2 in 2010, Operation Twist in 2011, and QE3 from 2012 to 2014.
People disagree about whether all those “kick-start” interventions were any good. I won’t get into that here. But everyone can agree that, despite all the stimulus, the economy never fully hit its straps. Everyone expected slow growth, and slow growth is what we got.
Trump is changing that.
Bonds for the bad times
The bond market shows what’s going on.
Here’s how it works: the issuer of the bond gets a sum of money, which is called the principal. In return, the bond issuer agrees to pay a fixed amount of money every year (that’s called the coupon) for a fixed period (that’s called the maturity). The maturity could be anything from a year to 30 years. When that period is up, the issuer repays the principal. So the bond is a promise of a pre-agreed stream of money into the future.
The good thing about a pre-agreed stream of money is that its predictable.
The bad thing about a pre-agreed stream of money is that it’s fixed. If you buy a 30 year bond from the US government, yes you’ll get a steady stream of cash… but what if conditions change in the meantime? A lot can change in 30 years.
So what do bond holders worry about? When it comes to bonds issued by the US Government, there are two main things to worry about.
The first is inflation. Bond investors hate inflation with a passion, because they’ve paid for a fixed amount of income every year. Inflation makes their fixed income stream less valuable.
The second is interest rates. You can think of this as opportunity cost. If I buy a 30 year US Government bond and interest rates start rising, I’m a sucker. I’ve locked in lower returns than I could’ve gotten in the market.
Bonds do better when the economy is running cold, and inflation is low.
And that takes me back to Trump.
Where others failed
Since Trump’s election this week, long term bonds sold off in a big way. In other words bond investors decided that a Trump administration is going to cause some combination of higher interest rates and/or higher inflation.
So bond investors are less willing to lock in a steady flow of income today. They think they could maybe do better by “putting their money to work” in riskier parts of the market.
A survey of fund managers by Bank of America between the 9th and 14th of November found the same thing. The survey found that bond managers are expecting long term bonds to sell off in a big way. They say they’re “putting cash to work”, by investing in riskier stuff like stocks, at the fastest pace in six years.
Trump just showed up.
P.s. Don’t take this to mean Trump’s going to be good for the American economy. He might bankrupt the government and create lots of inflation – that would be perfectly consistent with what we’ve seen in the markets this week.