Trump Victory Calls Next Round of Fed Rate Cuts Into Question

It seems that the market has spoken and, with Donald Trump elect getting 276 electoral votes, he has been called as the next president of the United States. Much ink has been spilled as to what that would mean for asset classes, mostly about how it is bullish for equities given Trump's pro-growth policies and bearish for bonds given his desire to spend even more. 

On Wednesday morning, like clockwork, equities are up 2% and bonds are getting slammed with 10-year yields squeezing north of 4.47% and counting. There is no demand for U.S. bonds, especially as the U.S. is going to embark on even more spending and issuing more paper, according to Trump’s agenda.

What makes matters worse is that Federal Reserve Chair Powell is set to keep cutting rates at a time when the bond market has been shrieking for them to stop. 

We know that the Fed panicked back in September after seeing the weak data post hurricanes, and jumped to conclusions. It mostly followed the bond market that saw its yields fall. Today, when we are seeing better employment data and even non-manufacturing PMI and other metrics hold up higher, it seems bonds have gone the other way and priced that "growth" in. This the first time that bonds have actually fallen so much after the first fed rate cut. Will the Federal Reserve follow? That remains to be seen. Either way, Powell is in a pickle, as we know, given the higher cost of servicing their debt and to boost lending and the mortgage market, the Fed feels rates are quite restrictive. But that will only boost inflation even more, even though it never got down to their 2% target.

Trump's mandate is clear, he is going on a spending spree; a fiscal spend using pro-growth policies. That, too, will see higher inflation, leaving very little room for the Fed to cut rates right now. The more prudent path would be to stay on hold until more evidence is seen. If the central bank does not step in fast, the U.S. bond market could lose all bids whatsoever, especially since there have been fewer buyers of paper post the Ukraine/Russia war. It may need to do "a Japan" and become the buyer of last resort, effectively instituting yield-curve control.

Over the past few months, equities have been cheering a dovish Fed. It had pencilled in about 250 BPS of cuts but today, the bond market has unwound more than three-quarters of that while the equity market has yet to catch on that rates may perhaps never go down much below 5%. Will it start to wake up as yields touch almost 5% again?

All eyes are on Powell. But if the labor market and inflation are his true gauge, then neither calls for a cut, despite the market pricing in 100% of a 25 BPS cut. If they cave in and cut at a time when equity markets are at highs, without even a recession on hand, then it's game over for inflation and the bond market. So, what will it be Powell?

At the time of publication, Bengali had no positions in any securities mentioned.