The problem with the Trump trade

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For some heavy hitters (and big egos) in markets, the worst possible outcome from the US presidential election is a victory for Kamala Harris.

A narrowing or even vanishing lead in the opinion polls for the Democratic candidate, mixed in with a big rise in wagers on her rival in the betting markets, have been enough to convince a good chunk of macro hedge fund managers that Donald Trump is on his way back to the White House. Some wishful thinking by speculative investors (who skew white, male and wealthy) could also be at play.

Political wonks still often say the election is a coin toss, and that the political betting markets are unrepresentative and best ignored. BlackRock chief Larry Fink this week argued that the result of the election “really doesn’t matter” for markets — a relaxed stance that it’s fair to say is not universal. In any case, once unleashed, a political frenzy — among certain types of investors at least — is hard to suppress.

Bankers compiling the views of their hedge fund clients talk of an overwhelming consensus expectation of a Trump victory — an outcome that they believe would point to higher US government bond yields and a stronger dollar. This would be the result of his more inflationary policy leanings such as aggressive tariffs on imports and crackdowns on immigration that are likely to accelerate wage growth. For the hedgies holding this view, the Trump trade is very much on.

This is playing out now. Both long- and short-term US bond yields have picked up markedly in the past 10 days or so, reflecting a drop in prices. The two-year yield — a decent guide to where traders believe benchmark interest rates are heading — has picked up by about half a percentage point to a little over 4 per cent. The 10-year yield has swept higher more forcefully, to 4.2 per cent or so, while the dollar index has gained 4 per cent. 

Interest rate option markets — again a happy hunting ground for speculators — are pricing in some pretty wild moves in US government bonds in the immediate aftermath of the vote, perhaps as much as 0.33 percentage points on the 10-year Treasury yield — a significant whack for this market.

The sense now is that a victory for Harris could see these bets by speculative investors turn into a so-called “pain trade”. This paints a picture of investors across the board consumed by election fever. But that’s not quite right.

Several things stick out here. One is that stocks are still pushing higher in a pretty orderly fashion — the flickers of volatility are confined to rates and currencies, which again suggests investors as a whole are sitting back and refusing to get sucked into hedge funds’ speculative game. Another is that it’s important to remember what else is happening in election week, namely a US interest rate decision and the release of fresh non-farm payrolls data.

In addition, it is still possible to explain away a large slice of this volatility simply on the surprisingly rosy economic data of late, particularly in the form of September’s blowout non-farm payrolls report. So the Trump trade is on, but it is a bit of a mess.

“Opinion polls have definitely shifted, not necessarily in favour of Trump but with a fading of momentum for Harris,” said Vasileios Gkionakis, a strategist in the multi-asset team at Aviva Investors. “But there’s a lot going on in the underlying data — upside surprises in the US data and downside surprises for the rest of the world. The bulk of the increase in yields seems to be driven by that.”

Indeed, the recent market noise around Trump appears to greatly exaggerate his true impact on most investors’ portfolios. “From our perspective, while the narrative has shifted a lot, market pricing is a lot more cautious,” wrote George Saravelos, an analyst at Deutsche Bank, in a note this week. For example, the value of the dollar was still in line with gaps in interest rates between the US and other major economies, he said, with just a sliver of politics on top. A full-on trade war and lavish fiscal largesse would call for the euro to drop close to $1, he calculated. Right now, it is some distance from there, at $1.08.

Tariff-sensitive US stocks had also been “largely moving sideways”, he noted. All in all, “the market has started to price an increasing probability of a Trump win, but the degree to which this is impacting market pricing is still quite modest”.

Despite the natural outburst of nerves or excitement around the election, such caution remains the right path for all investors aside from those with sufficiently high risk tolerance to take a gamble.

“People are really trying to figure out what Donald Trump would mean in terms of economic growth, monetary policy and inflation,” said Guy Stear, head of developed market strategy at the Amundi Investment Institute. “But there’s just too many uncertainties,” he said. 

If rates markets swung around wildly after the election, fund managers might be able to jump in and snap up some bargains, he said. For now, though, “it’s so uncertain that it’s dangerous to be decisive at the moment”. Patience remains the best policy.

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