PrefBlog

There is continued excitement over potential US fiscal stimulus:

A bond-market gauge on Thursday hit its highest level since the summer of 2015. The 10-year break-even inflation rate indicated expected annual inflation of 1.89% over the next 10 years. That measure, reflecting the gap in yields between Treasurys and their inflation-protected counterparts, known as TIPS, was 1.73% two days ago, according to Tradeweb.

The yield on the 10-year Treasury note, which rises when bond prices fall, climbed another 0.05 percentage point on Thursday to 2.118%. It has jumped a quarter of a percentage point since before the U.S. election result, the biggest two-day rise since 2011. Nominal bond rates have been rising faster than those protected against inflation, meaning that inflation protection is increasingly viewed as the more attractive investment.
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One spark for the latest inflation trade came when Mr. Trump mentioned infrastructure spending prominently Wednesday morning in his victory speech, investors say. Others believe efforts to repeal financial regulations enacted by President Barack Obama’s administration could expand bank lending activity, and that restrictions on trade could boost wages in an already strong labor market.

The New York Times has a bit more colour:

For the last few years, the world has suffered from a chronic shortage of demand, depressing inflation and interest rates worldwide.

If those conditions persist, a Trump administration may have some room to expand deficits without triggering a spike in interest rates that would undo any economic boost those deficits create.

But many economists don’t see it working out that way. Mark Zandi, chief economist at Moody’s Analytics, was skeptical in a much-discussed paper released earlier in the year estimating the economic impact of a Trump administration. He assumed that if Mr. Trump’s policies were taken at face value, it would increase the deficit from 3.5 percent of G.D.P. this year to more than 10 percent by the end of Mr. Trump’s term. He said this would cause the Federal Reserve to raise interest rates above 6 percent in 2018 to prevent inflation.

Who’s up for a 6% Fed policy rate? Who wants to know what will happen to the loony and Canadian house prices then?

Those hoping for higher global interest rates via expansionary fiscal policy may soon get their wish:

Donald Trump’s gracious victory speech did two things. It defused much of the negative impact of the shock; and it reminded everyone that the US would have a more expansionary fiscal policy under a Trump presidency than it would have done under a Clinton one. This latter point may take time to be reflected in the markets, and the negative tone on international trade will put pressure on emerging markets. But it is quite plausible that US shares will rise rather than fall over the next few weeks. The dollar should recover swiftly too.

The reason for this is the easing of fiscal policy. With a supportive Congress it should be possible for the new President to get his proposed cuts in both corporation tax and income tax into law next year. Big business did not support a Trump victory but it will benefit from it. Of course, recession fears remain, for this has been a long expansion and the economy is pushing towards full capacity, but US growth next year may surprise on the up side, not the down. Additional spending on infrastructure will take time to feed through – there is no such thing as a shovel-ready project – but such investment will inevitably add to growth in the medium-term.

It is hard, however, to see growth being fast enough to close the budget deficit. A looser fiscal policy will be countered by a tighter monetary one. There was great hostility in the Trump campaign towards the Federal Reserve and to its chair Janet Yellen. But the Fed is independent and it would be unwise of any new administration to pick a fight with it. Right now the markets estimate that the chances of another rise in interest rates in December have shrunk from a near-certainty to an even bet. But this election increases the intellectual case for higher rates. Once they have settled down the markets may come to accept that such rises are inevitable and welcome.

There’s good support for this view:

The Committee for a Responsible Budget said this has made it difficult to evaluate Mr. Trump’s proposals, but estimated they could add $5.3-trillion (U.S.) to the federal debt over 10 years.
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The initial impact of Mr. Trump’s protectionist policies may not be all bad. Economist Barry Eichengreen argued earlier this year that while tariffs threaten to fan trade wars and geopolitical tensions, the initial impact would be to boost U.S. wages and inflation, something the Federal Reserve’s easy money policies have so far struggled to accomplish.

Mr. Zandi’s team at Moody’s Analytics estimates that fully implementing Mr. Trump’s trade and immigration proposals could drive up inflation, eventually triggering aggressive Fed rate hikes and a recession, a concern shared by some investors.

PerpetualDiscounts now yield 5.13%, equivalent to 6.67% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.9%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 275bp, a sharp narrowing from the 290bp reported on November 2.

Sweet Baby Jesus:

Click for Big
Just before midnight on election day

The markets could be interesting tomorrow:

Panicked investors rushed to unwind bets they’d piled on amid predictions Clinton would sweep to victory. Futures on the S&P 500 Index plunged more than 4 percent and Mexico’s peso — which tends to weaken as Trump’s prospects improve — sank by the most in two decades. U.S. Treasuries, the yen and gold all soared by the most since Britain’s surprise vote to leave the European Union sent shockwaves through markets in late June.