What kind of President will Donald Trump be? Will he restore America to its
former position of greatness, or end up being feckless like a long list of
his predecessors? That is yet to be determined.
However, what is clear now is if Donald Trump wants to avoid starting his
tenure with an economic crisis similar to that of Mr. Obama he will need to
put a lid on long-term interest rates rather quickly. And in order to do that
he will have to convince a supposedly politically-agnostic Fed Chair, Janet
Yellen, to not only refrain from further interest rates hikes but also to launch
another round of long-term Treasury debt purchases known as Quantitative Easing
(QE).
The move higher in Treasury yields since the election of Trump has been nothing
short of violent, but borrowing costs were already on the rise prior to November
8th. The Ten-year Note Yield began its ascent after it bottomed at 1.36% back
in July. This is because central bankers arrived at a new conclusion: that
a steepening yield curve would be best for the banking system and economic
growth, rather than to just continually push long rates lower. The Ten-year
yield climbed up to 1.83% on the day prior to the vote, then spiked to over
2.30% several days after America made its choice for president.
But why is the election of President Trump so bad for bond prices? The answer
is twofold. First, Trump's pro-growth policies of lower corporate and personal
taxes, in addition to reduced regulations, are causing investors to sell fixed
income products and to place funds in equities. Growth stocks simply offer
the potential for better returns than the current historically-low yields found
in bonds. Second, and most importantly, a Trump presidency is highly inflationary
because his massive $1 trillion infrastructure refurbishment plan, along with
his proposal to rebuild the military, will—at least in the short-term—significantly
increase annual deficits. In fact, deficits are already soaring; the fiscal
2016 budget hole jumped to $587 billion, up from $438 in the prior year, for
a huge 34% increase.
Enormously growing deficits, which will add to the intractable National debt,
tends to force a central bank into an ultra-loose monetary policy. But it's
not just the $20 trillion public debt that will put pressure on the Fed to
keep printing money. Total Non-financial Debt has soared from $33.1 trillion
at the end of 2007, to a record $45.6 trillion in Q1 2016. That means debt
as a percentage of GDP has climbed from where it was prior to the Great Recession
(226%), all the way up to 250% of the economy.
A central bank that vastly increases the money supply, one that far transcends
the legitimate pool of savings, is the tool used by governments to keep interest
rates from skyrocketing. This has been the recipe for runaway inflation since
the beginning of economics.
In addition to this, Trump's protectionist trade policies would implement
either a 35% tariff on certain imports or would require these goods to be produced
inside the United States at much higher prices. For example, the increase in
labor costs from goods made in China would be 190% when compared to the federally
mandated minimum wage earner in the United States. Hence, inflation is on the
way.
The incredible nearly 50 basis point surge in the Benchmark Treasury yield
in the immediate wake of the election is proof of Trump's fiscal profligacy
and his inflationary impact on the nation.
The end of the 35-year-old bond bull market is upon us. Trump's trade policies,
along with his avowed love of debt, is putting significant upward pressure
on borrowing costs. The Donald will now try to convince Janet Yellen to reverse
her incipient tightening policy and bring rates back to zero—and eventually
even to launch QE IV.
If rates continue to rise it won't just be bond prices that will collapse.
It will be every asset that has been priced off that so called "risk free rate
of return" offered by sovereign debt. The painful lesson will then be learned
that having a virtual zero interest rate policy for the past 90 months wasn't
at all risk free. All of the asset prices negative interest rates have so massively
distorted including; corporate debt, municipal bonds, REITs, CLOs, equities,
commodities, luxury cars, art, all fixed income assets and their proxies, and
everything in between, will fall concurrently along with the global economy.
For the record, a normalization of bond yields would be very healthy for the
economy in the long-run, as it is necessary to reconcile the massive economic
imbalances now in existence. However, President Trump will want no part of
the depression that would run concomitantly with collapsing real estate, equity
and bond prices.
But the problem is he will be asking Ms. Yellen to do the exact thing he accused
her of doing during the campaign. Namely, being a political puppet of the President.
If the Fed is truly apolitical, she will politely refuse. Nevertheless, what
Yellen and Trump don't understand is that our nation is both debt-disabled
and asset-bubble addicted, which requires interest rates to be near zero percent
or the whole ersatz economy will implode. The devastating bond bubble's collapse
will bring Trump to that reality very soon. And if Ms. Yellen doesn't agree
to pick up the speed on the printing presses she may hear the words "Your Fired",
even before her tenure is up in February 2018.
