What Will President Trump Mean for Bond Yields?

MARKET REACTION: Will the Fed raise US interest rates next month? And what will that mean for global bond markets?

Emma Wall 17 November, 2016 | 11:29AM
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Emma Wall: Hello and welcome to the Morningstar Series, Market Reaction. I am Emma Wall and I am joined today by Charles McKenzie, Chief Investment Officer for Fixed Income for Fidelity.

Hello, Charles.

Charles McKenzie: Hello.

Wall: So a week after the shock election of Donald Trump as the next President of the United States. Prior to this result, we were very much expecting the fed to raise rates in its meeting in December. Do you think this will still go ahead?

McKenzie: You know, I do. I think we will certainly go ahead in December. In fact the market is almost giving it 100% probability that the fed is going to raise interest rates in December. So I don't think that's changed anything at all.

Wall: And looking to what we were expecting from 2016 the fed indicated there would be four rate rises. We haven't got that. What should we expect in 2017, in particular, because a lot of the policies that Trump has spoken about are inflationary?

McKenzie: Yes, and I think the markets are trying to work out exactly what the Trump victory means for the U.S. treasury market. Clearly at the moment there is an awful lot of concerns about reflating the U.S. economy and how inflation might feed through into the U.S. system. And of course with much greater perhaps fiscal spending a greater supply of government bonds coming to the market meaning – whereas basically been a bear steepening of the market i.e. longer dated U.S. treasury bonds have been underperforming.

Now, what does that mean? Well, actually the fed are probably likely to raise interest rates going into 2017. We're expecting probably about two rate hikes going into next year.

Wall: Of course, we don't have to wait for a rate hike to see a change in bond prices. This is a market at the moment that is so much about sentiment in both the fixed income world and indeed equities. And we have seen bond prices reflect those rate rises to come, haven't we, which is causing some people to say this is it finally the bond bubble is bursting?

McKenzie: Yes, and you’re right and the markets have reacted very aggressively in terms of that, but we also have to step back a little bit. We’re right now in the middle of what feels like a storm, and U.S. treasury bond prices have sold off. But yields still are lower today than they were at the beginning of the year, which is I think, we just need to take some sort of a perspective on this. I think we also have to be aware of there is still significant structural headwinds to global economic growth.

We have a huge amount of debt in the global economic system, so it’s going to be quite hard for global economic growth really to power through. And we are already talking about the U.S. economy here. If we start expanding our horizons into Europe, into Japan, into emerging markets, their headwinds to growth are quite significant. So, it’s really only the fed who are likely to be in play in terms of raising interest rates.

Other central banks are still in the mantra of keeping rates low and very much low looking for quantitative easing. So, I certainly think it’s very premature to call the end of a bond market rally because an awful lot of structural headwinds in other parts of the world which will keep yields relatively low.

Wall: Of course that means that if the U.S. does raise rates and indeed other parts of the world keep this very low rate environment, we will see a disconnect, wherein at the moment over the last couple of years, developed markets are sort of been moving together. What does this mean for investors of bonds to suddenly have this two way market?

McKenzie: An opportunity actually. Actually, I think it does give a great opportunity because bonds markets currently dislocate so far, but it was always going to be a link between different bond prices. But what I think it certainly gives our bond investors are opportunities. Greater volatility, gives greater opportunities.

So, people can certainly look for opportunities, for example, regional differences, but also inflation linked bonds compared to nominal bonds. Even in the credit markets, there’s clearly all sort of changes in regulation, which is going to affect perhaps the financial sector, that will undoubtedly throw up opportunities for bond investors in the months and years ahead.

Wall: Charles, thank you very much.

McKenzie: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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