Some Post-Election Thoughts

It’s a bit hard to write about markets right now given the election outcome, but I’d like to say a few things in light of the market action and the endless string of “Trump Trades” reports that are being sent around.

· No one knows what Trump wants to do. And even if that is known, no one knows what he’ll be able to do. Trump is facing not a simple Republican majority in Congress but rather a minority of ‘core’ Republicans, the Freedom caucus, and Democrats. Thus, a massive federal fiscal deficit is almost certainly going to require the buy-in of a large number of Democrats.

· Barriers to trade are a different story, since Trump does not need Congressional authority to throw up roadblocks. As a result, the moves in currency crosses vs the USD are arguably likely to be more persistent for those with a large trading relationship. Note that the roadblocks (including a currency manipulator designation) do not even need to take effect to justify these moves. The very threat is likely to restrain US companies from building factories outside the country, and dissuade foreign companies from exporting here. This suggests that the US non-petroleum trade deficit is likely to stabilize, at the very least.

· Having said that, the paradigm for US rates has abruptly changed. Treasuries are no longer seen as simply as cash like instruments, or risk off hedges. Now there is a clear downside risk via a worsening fiscal deficit, and the market is moving to price that risk premium.

· Having said that, remember that there is a limit to how high that risk premium can go. Japan has shown that the sovereign Debt/GDP ratio is much, much higher than here.

· I’ve been doing some more modeling for US rates and now believe that the fair value for nominal 30y Treasuries to be close to 2.5%.

· The selloff in fixed income is likely to accentuate inflows into equities. Most surveys suggest that investors are underweight risk assets, but there hasn’t been an impetus to reverse that given that fixed income has been performing all year. There are a few similarities to 2013 there.

· The market tone for US equities is unambiguously bullish. If a massive uncertainty shock like this AND a massive jump in treasury yields can’t send the market lower, it’s hard to imagine what will in the near term.

· Volatility spikes like what we’ve seen the past 24 hours will persist. Successful investing thus requires a combination of correct position sizing, fortitude, or ignorance.

· In my last update back in August, I said that shorting duration and being long equities is likely to work over the intermediate term. The former call has worked better than the latter, but I think those views still apply, though obviously the case for short rates is less strong now given the move.

· I also like USDCAD upside over the longer term. Regardless of what happens politically, Canada needs both lower interest rates and a weaker currency vis-à-vis its largest trade partner. Plus it is positive carry, and negatively correlated to risk assets. It’s not necessarily a fantastic trade based on an ex-ante Sharpe basis, but should work well as part of a pro-risk portfolio.

· For the EURUSD, barring a hiccup in Europe, new lows are likely to be limited. Beneath all the noise, Europe has been closing its output gap at a faster pace for about a year and a half now. IMO, that is one reason why the ECB is even hinting about tapering, which arguably is a much more hawkish shift than the Fed resuming its gradual hiking path. Real yield differentials in the belly of the curve has increased 60bps (!) in favor of the EUR since a year ago. The current market tone is focused on protectionism and the dollar positive effects from that, but a substantial move lower here would make a long position attractive, IMO.

As always, thoughts & responses are welcome.

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2 thoughts on “Some Post-Election Thoughts

  1. Great summary!

    What are your thoughts on the curve steepening causing a pullback in extended EM positioning? personally feel after dust settles could be good time to buy the EM dip..

    Do you buy the fiscal spending > inflationary risk argument? i think people were already buying the inflation story crude yoy +ve and yellen hinting she doesnt mind the economy run a little hot so perhaps we could see more fuel to the fire?

    You mentioned that Trump does not require congressional authority to implement what people fear are to be isolationist anti trade policies. I am very skeptical of this view knowing that he would have subtantial opposition from many stakeholders and i am one to lean to the potential that trump and co are aware that some damage control might be needed to ease concerns and that his advisors won’t let him run too astray – what are your thoughts on this?

    1. Thanks Buena!

      I don’t think folks are not all that overpositioned in EM, if for no other reason than the fact that people seem to be underweight risk assets in general. Buying EM assets here seem quite reasonable to me.

      I do think fiscal spending here will be inflationary, especially since we are already at or close to full employment. In addition, I think people are worried about Trump’s statement that he wants to levy a 35% tariff on imports from Mexico and China, which would have very discernible impacts on inflationary dynamics. As you noted, this adds to the inflationary concerns given Yellen’s comments. Having said all that though, most of those impacts are likely to last only a few quarters, given that the Fed will need to tighten more aggressively to counteract them.

      You are certainly right that many of Trump’s economic advisers will remind him of the negative economic impacts of anti-trade policies. But consider that anti-trade was one of Trump’s key campaign themes. He will feel compelled to do something on that front regardless of what his advisers say, though it will likely to more moderate than his statements during the campaign. That’s my feeling, anyway.

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