The Fed rate hike is back on, even with Trump in the White House
City Index November 9, 2016 7:16 PM
<p>Reaction to Trump’s shock win in the US election continues to be relatively muted as we move to the final stretch of the London session. […]</p>
Reaction to Trump’s shock win in the US election continues to be relatively muted as we move to the final stretch of the London session. Equity markets are generally lower, however, losses are not of such a magnitude that they suggest market panic, in contrast, the markets appear to be sanguine about a Trump Presidency, which dramatically increases global economic uncertainty. Perhaps Trump’s conciliatory tone in his victory speech has eased concerns about his Presidency, or perhaps markets have no idea how to price in his victory as we have no precedent for someone like Trump. Either way, a mere 24 hours ago no one would have predicted such a calm market reaction on the back of this result.
Trump not an obstacle to a Fed rate hike?
In the lead up to the election result we looked at market expectations of a Fed rate hike to see if it reflected the election polls. On reflection perhaps we were naïve to think higher expectations of a Fed rate hike signalled a win for Clinton, rather than for Trump. The Fed Funds futures market is a reliable indicator of market expectations for interest rates. Prior to the polls closing, expectations for a Fed rate hike in December were above 85%, during the results expectations fell below 50%, and at the time of writing they are now above 80%.
So a Trump Presidency does not appear to be an obstacle for a rate hike from the Fed. This could be for two reasons: 1, Trump’s softer approach in his victory speech may suggest that he will leave the Fed alone, and allow them to get on with their job, which includes hiking interest rates. 2, Considering the win for Trump hasn’t been America’s Brexit, the Fed does not need to refrain from hiking interest rates to supress market volatility and protect from stock market declines. Interestingly, expectations for more than one hike next year have also risen on Wednesday.
Bond yields a major mover on Wednesday
This is significant for bond yields, which have risen strongly today. The 10-year Treasury yield is back at its highest level since March, above 1.90%, which is 20 basis points higher on the day. For now we think that higher yields represent optimism for the US’s economic outlook, possibly because the Republicans have control of the Senate, which could boost growth. It could also be a sign that the US will have to borrow more to fund Trump’s planned infrastructure spend that he mentioned in his victory speech. But, if yields continue to rise at this pace then concern may grow that bonds are selling off due to fears of America’s creditworthiness under a President Trump, who said that he may default on some of America’s debt burden.
A Trump boost for the dollar
Rising bond yields are also significant for the USD, as they have been the building blocks of this dollar rally. After selling off sharply late on Tuesday, the dollar has been in recovery mode ever since Trump looked like a winner. At the time of writing the dollar index is virtually back to where it was prior to the close of polls on Tuesday.
What our clients are doing?
It is worth noting that our clients are also buying into this recovery in the dollar. Of our clients that trade USD/JPY 58% are long, while clients that trade EUR/USD, 62% are short. USD/MXN IS 62% sold, suggesting that our clients could be squaring up short peso positions, potentially because they think that the Trump news is now priced in after USD/MXN reached a record high on Tuesday night/ Wednesday morning. Although our clients are net short of the S&P 500 and FTSE 100 on Wednesday, it is not as large a percentage of sellers as you might think on the back of such a large political shock, 65% of those trading the S&P 500 are short, with the same amount for the FTSE 100. Thus, our clients, like the markets, seem to be having a restrained reaction to the Trump news.
This price action definitely feels strange, and was not what we had expected. We still think that there are considerable risks to a Trump Presidency, and risk sentiment could remain fragile in the coming weeks and months. It is difficult to determine if the rise in Treasury yields is a sustainable trend, we are beginning to think it is since it is backed up with soaring expectations of a Fed rate hike for next month. For now, this is likely to sustain a rally in the dollar, particularly against the EUR, JPY and GBP, which could see further declines against the greenback in the next day or so.
GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.