I find it striking that even though Donald Trump beat Kamala Harris (by more than three percentage points) in the national vote, the GOP only managed to flip so few seats in the Senate and the House. The House is going to likely be a razor thin majority replete with 38 Freedom Caucus members. The bond market is freaking out, but Trump may end up having more trouble with his fiscal plans in the House than many think at the moment. And that includes many of his budget-busting but vote-grabbing tax cut goodies.
It is interesting how the down ballot vote didn’t match his success at the top. And Harris received less of the electoral vote than Hillary Clinton, which says a little about what voters are signaling. They obviously didn’t like her at all and obviously preferred Trump – but not all of his policies outside of the border and his constant slogans of bringing down inflation. If voters liked his budget policies, the down ballot vote would have come closer to the huge win Trump enjoyed at the national level. The reaction in equities is massive but understandable — deregulation etc. But the bond market is overplaying the fiscal implications, in my view. There is no debating the freak-out session in the Treasury market. The stock market is overcome with greed and the bond market with fear. Fear of massive fiscal deficits. Fear of inflation. Fear the Fed will kybosh the easing cycle. I understand it.
And nobody can say for sure at this point whether the carnage in the bond market and euphoria in the equity market is over right now. Extreme sentiment can move to further extremes in markets driven by greed and fear and where perception dominates reality. For the equity market, it is all about “dereg!” and that is a confidence booster. More shackles are taken off the Financials and no big fight with Big Pharma. Visions of a mega M&A cycle have equity investors salivating. And, of course, the memory of the last GOP sweep in November 2016, though I should add that the equity risk premium – the difference between the S&P 500′s earnings yield and the yield on 10-year Treasurys – was nearly 400 basis points back then and a mere 15 basis points today. Does anyone look at that anymore? Meanwhile, the stock market has done in two days what it took two months to accomplish in the bull move after the November 2016 election.
The surge in bond yields from the levels in early October when Trump began to pull ahead in the polls took a month and change this time around, whereas it took nearly five months to achieve after the November 2016 election. So much has been discounted in such little time in a signpost of a highly speculative financial market. As for equities, investors may be in for a surprise that the corporate tax relief will be less than what has been advertised.
The House is likely not going to play ball with a 15% top marginal corporate tax rate or the array of other election campaign goodies (including tips, overtime, and Social Security). This is not 2016 when the deficit-to-GDP ratio was 3%, and not 6%, and the debt ratio was at just over 100% and not making a run for 130%. And the House is definitely made up of fiscal conservatives on both sides.
As for bond investors, I say chill. If equity investors are playing from the Trump playbook, so should you. In the end, it was the same policy prescription — lower taxes, rising deficits, tariff hikes, immigration curbs. And yet with all that, before all the distortions from the pandemic and the myriad of policy responses to it, we entered the COVID-19 crisis after more than three years of a Trump tenure, with inflation and Treasury yields pinned around 2%. Ergo, the inflation hyperventilating after Trump was first elected proved to be not just excessive but plain wrong. Plus ça change… we have seen this movie before.
At issue for the bond market is that the swaps curve in recent weeks has taken out nearly 100 basis points of rate cuts next year. That seems radical to me because nothing Trump is going to do will land until 2026. Remember, the tariffs and tax cuts in the last go-around didn’t occur until 2018 — 2017 turned out to be an okay year for Treasuries, helped in part by the higher starting point for the yield after the spasm that took hold right after the November 2016 Trump victory (sound familiar?). This time around, however, there are more fiscal and even political constraints on what he is going to achieve via deficit finance.
As I said at the outset, investors are not looking at what I am paying attention to, which is the gap between the top-line vote that brought Donald Trump back to the White House and the down-ballot result, especially the tightness in the House, which does, after all, initiate all bills in the legislative process. This tells me that despite Trump’s very low personal approval rating, voters disliked Kamala Harris even more, that what we saw on Tuesday was a repudiation of the policies over the past four years, and a pushback against the leftward lurch within the Democratic Party. At the same time, there was a message in the fact that to this day, the House is too close to call (though the odds heavily favor the Republicans).
This was not a vote for fiscal recklessness. Outside of the border issue, bringing inflation down further was a critical Trump policy plank during the campaign. His last tenure was one of moderate growth, little better than Barack Obama and there was no boom. What did take hold was a backdrop of low and stable inflation and a return to a bond bull market even before the pandemic reared its ugly head.
This reminder may be met with deaf ears from a bond market crowd that has been thrashed of late — but if inflation was a critical policy plank in the campaign, I feel assured that there is absolutely no public appetite for deficit-led inflation and if the Republicans don’t deliver on this, then brace for political change in the other direction in the 2026 midterms.
Why it is that I am the last bond bull standing, understanding at the same time that the upward yield momentum may continue over the near term as scared-off fixed-income investors shun duration exposure. But I go back to that last Trump era, and those widespread inflation fears at the beginning proved to be too extreme. I made the claim back then, which was proven to have been prescient when all was said and done. And I’m playing from that same playbook this time around as I sense a classic Yogi Berra déjà vu all over again.
David Rosenberg is founder of Rosenberg Research.
Related:
Bond rebound uncertain as Trump plans overshadow Fed rate cuts
David Rosenberg: Investors are partying like it’s 2016-2018 again under Trump. That’s a mistake
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