Hooray! The “Trump trade” is back! Not really.
I mean, it is. I guess. Assuming you thought it was justified/real in the first place and assuming you ignore the fact that, as SocGen’s Kit Juckes wrote earlier today, “the moves over the last three weeks while big, can easily be dismissed as a reaction to the excessive gloom of late August when the fed wasn’t going to hike again in 2017, Donald Trump’s war of words with Kim Jong-Un was beginning to make daily headlines, hurricane season was just beginning to affect economic sentiment and hopes of any fiscal easing had died.”
In other words, there’s certainly some hint of the “Trump bump” creeping back into the market, but this “bump” is more of a “bounce” from lows that were themselves the product of everyone fading nearly every “Trump trade” on the board as it became increasingly apparent that the absurd expectations which served to make long USD and short USTs “sure bets” headed into 2017 failed to take into account the inherent uncertainty that surrounds making a reality TV show host the leader of the free world.
Then again, if that’s the case and nothing goes wrong-er-er from here, then it’s conceivable that there’s some gas left in the tank.
One way to look at things (and this is perhaps the simplest way to capture all facets of this debate) is simply to plot 10Y yields against Trump’s approval rating. Here’s a chart from Goldman:
So the question here is simple: is this sustainable?
Goldman thinks it might be. Or at least in the near-term.
And they’ve got three reasons why they believe that. Here they are, submitted for your consideration:
- First, as of early September, we think markets had become too pessimistic on the US policy outlook. For one, most of the equity baskets that our equity colleagues use to track ‘Trump Trades’ had completely reversed their post-election gains vs the S&P. In addition, Treasury yields had fallen substantially below our ‘fair value’ estimates and the Dollar had fallen over 10% against the majors in the first eight months of the year. And as our FX team noted at the time, the pessimism on the Dollar seemed to have run too far, a reaction that they attributed in part to the excess pessimism on the fiscal outlook and the inflation outlook in the US. So we would interpret much of the recent repricing as an unwind of undue pessimism.
- Second, there has also been genuinely positive news on the US policy front. Deficit hawks appear to have agreed to a larger-than-expected tax cut, perhaps signaling a greater willingness to make a deal to get some legislation done. And while the initial proposal will have to be scaled back to meet fiscal constraints in Congress, some of the most difficult proposals — such as a 15% corporate rate and border-adjustment — have already been eliminated. Finally, in wake of their failed, final effort to make progress on health care, house Republicans will now be under more pressure to show progress on significant legislation before the mid-term elections.
- Third, we continue to see more scope for upside surprises in the inflation indicators, as well as upward revisions in market expectations for policy hikes. We therefore think that US 10-year Treasury yields will continue to rise to our Q4 2017 range of 2.60-2.75%. We expect this to be driven by a repricing of real rates at the ‘belly’ of the yield curve (for reference, we think that 5-year TIPS will reach 30bp) promoted by expectations of further Fed hikes, and a rebuild of term premium. The latter will be lifted by the interplay of lower Fed reinvestments (‘quantitative tightening’) and higher expected Treasury supply.
Trade accordingly.
