The surprising message from bonds about a Trump presidency

NEW YORK, N.Y. – He’s called the spiraling federal debt a disaster, leads a party of avowed fiscal hawks and has promised to balance the budget.

But if you expect Donald Trump to act as a model of fiscal rectitude as president, the bond market has a message for you, and a very Trumpian one at that:

“Wrong!”

Investors have been yanking money out of bonds around the world since Trump’s victory became apparent early Wednesday, sending prices tumbling and wiping out several months of gains. They expect higher debt, higher inflation and higher interest rates — all negatives for bonds.

Bond investors can get things horribly wrong, and it’s only been a few days. But for a normally calm market, a sort of sleepy cousin of the stock market that has been mostly rising, it’s been a stunning turn of events.

“The bond market is supposed to be a dull, boring, stable place,” said Colin Lundgren, head of U.S. fixed income at Columbia Threadneedle Investments. “Instead, it’s been at the centre of the storm.”

After years of too little inflation, investors are worried that Trump will inadvertently kick off too much and send the national debt up sharply. If that happens, he could do something long forecast, and much feared: kill off the three-decade-long bond bull market that has lifted prices so high, and pushed borrowing rates so low, many experts think it’s a bubble ready to pop.

Investors are demanding more interest to lend to the U.S. government now because they fear higher inflation is coming as Trump opens the spending spigots to get the economy to grow faster.

He’s promised to deliver 3.5 per cent growth a year. That is much faster than the average 2 per cent or so recently, and higher than many economists think possible on a sustained basis.

To get there, Trump says he’ll slash regulations and taxes, and use federal tax credits to generate $1 trillion from private sources to fix and expand the nation’s roads, bridges, airports and transit systems. That has helped send stocks higher in anticipation of bigger corporate profits.

But the country will likely need to borrow more under Trump’s plans — a lot more, according to estimates from the non-partisan Committee for a Responsible Federal Budget. It says the combination of higher spending and lower taxes will add $5.3 trillion to the nation’s debt over the next decade. That is on top of the nearly $20 trillion in debt that ballooned under President Barack Obama and his predecessor George W. Bush.

The Trump campaign says his spending won’t be a problem because faster growth will increase tax revenue even at lower rates.

Michael Lewitt, a bond fund manager who says he voted for Trump, isn’t buying it.

“Cutting taxes and spending more money and not reforming entitlements, that’s going to send debt through the roof,” said Lewitt of the Credit Strategist Group. “The market is saying he is not going to worry about this, and that’s going to be bad for bonds — really bad for bonds.”

Another possible problem for bond holders is Trump’s protectionist leanings.

On the campaign trail, he threatened to slap tariffs on Chinese and Mexican goods and rip up trade pacts. If he follows through, that could stoke inflation by sending prices of imported goods sharply higher.

Bond investors loathe inflation because it erodes the purchasing power of their fixed payments.

A little more inflation might be a good thing, of course. If anything, the world has been suffering from too little of it. Consumer prices have risen 1.5 per cent in the past year, about a half point lower than what is considered the ideal level.

Higher inflation is usually a sign of faster economic growth, and it has a way of building on itself. It causes people to spend right away on things out of fear they might have to pay more for them later, and that can stimulate even more growth.

But it’s hard to contain inflation once it starts revving up. A Trump presidency, some investors think, makes it more likely the Federal Reserve will raise short-term borrowing rates next month to keep prices from rising too fast.

What makes this all unnerving is that the bond market is such a fragile place now.

The interest that investors are getting on some government bonds is lower than it has been in hundreds of years. Even a little more inflation could wipe out gains from collecting that interest over the life of their bonds, and so many investors are jittery and have moved fast to dump their holdings.

That is what happened in trading in the U.S. government bonds in recent days. Investors dumped Treasury notes due in 10 years, sending their yields soaring from 1.75 per cent to 2.15 per cent in just 36 hours. It typically takes many months for yields to move that much.

All this would be bad enough if there wasn’t so much debt at risk now. In the eight years since the peak in borrowing before 2008 financial crisis, governments, households and companies around the globe have taken on another $69 trillion in debt, a jump of 53 per cent, according to McKinsey Global Institute.

Given the complicated global web of bond trading, the danger is that a sudden drop in the price of bonds could trigger selling across markets and for many different kinds of assets. In the 2008 financial crisis, a drop in the value of mortgage bonds sent the prices of stocks and other bonds plunging as investors scrambled to raise cash by selling even things they thought were fairly priced.

Of course, bond investors could be getting the Trump presidency all wrong, and quickly start buying bonds they were just selling.

A Republican Congress might reject or at least limit any Trump stimulus that would entail gobs of additional spending and borrowing. And just how much Trump wants to spend is unclear because he was so vague on the campaign trail about his plans, and he has no political record.

James Abate, chief investment officer of Centre Asset Management, says bond investors have plenty of reason to worry, though. It’s not just Trump’s campaign promises. He spent his business career, after all, as a developer putting up buildings, and borrowing a lot to do it.

“Project what he’s done his entire lifetime, and think of that on government level,” said Abate. “He’s going to issue debt, and that is what the bond market is spooked about.”

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Bernard Condon can be reached at http://twitter.com/BernardFCondon.