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Bond vigilantes and Trump’s fiscal promises

Now it’s been just over a week since US voters surprised the world by electing the controversial Republican candidate Donald Trump. To what investors perceived to be, possibly, another Brexit in terms of volatility, the equity market turned bullish in line with, among others, Trump’s fiscal expansion promises, following earlier declines.

On the contrary, we’ve seen a re-pricing over the bond market, mainly the US Treasury curve and understandably emerging market bonds. For those investors’ who are continuously monitoring the current situation within the financial markets nothing said till now is new.

What is interesting now to see is whether Trump will manage to implement his aggressive domestic spending agenda or whether he will be constrained in doing so, not by the Republicans or Democrats but by the so-called ‘bond vigilantes’.

Interestingly enough this term refers to bond investors’ who tend to rebel against fiscal or monetary policies by inducing a sell-off across the bond market which in turn push yields higher.

In this regard, the vigilantes emerge as gate keepers and impede the government’s ability to over spend/borrow due to higher borrowing costs. Usually, governments are restrained by debt ceilings.

For instance, way back during the Eurozone crisis the high borrowing costs faced by PIIGS countries was also brought about by bond vigilantes which had pushed yields higher.

Looking back in history, the last time such keepers acted into place in the US was back in the 1990s when they raised their action by stepping-in to tone down Clinton’s spending agenda.

In his campaign Trump clearly indicated his pro-fiscal expansion vision by introducing sharp tax cuts for businesses and individuals and upwards of $1 trillion in spending to rebuild infrastructure roads, bridges and other parts of America.

Trump’s plans will probably trigger the now already experienced by Obama’s administration debt ceiling approvals by the senate.

The only difference this time round is that President elected has the senate’s support as this will be once again denominated by the Republicans. The only possible constrains which I can envisage would be the internal turmoil among the Republicans themselves.

What is interesting nowadays is that as opposed to the recent years whereby fiscal stimulus was in short supply, monetary stimulus was strong and thus yields crashed lower, this time round yields commenced pricing the possible inflationary pressures going forward.

Viewing it from such perspective, many may argue that the bond cycle which was very benevolent to investors over the past years might be over.

That said despite the market has been pricing Trump’s fiscal expansion policies, and in my view markets were slightly overactive, let’s not be so sure that the theoretical ‘bond vigilant’ term will not put pressure and constraints on fiscal expansion policies.

In this regard, despite experiencing strong movement across the sovereign curve over the past days, going forward let’s not totally exclude seeing the fixed-income market re-pricing upwards in the short-term following the recent correction.

Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website. 

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