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The growing consensus that a Trump presidency will lead to higher bond yields, and by association higher mortgage rates, has me scratching my contrarian itch.
It’s true that U.S. bond yields have surged higher since President-elect Trump’s victory, taking Government of Canada (GoC) bond yields along for the ride. But does this recent sell-off signal that the bottom for bond yields is in, or will it prove just a temporary blip?
In the immediate aftermath of the election, we just don’t know. Dow futures plunged 800 points in after-hours trading on election night, and the next day finished up 250 points, so while volatility certainly ruled the day, the market’s true conviction was not clear.
That said, contrary to what many market watchers seem to have now concluded, I think it’s going to take more than just a Trump election win to signal the end of the longest bond bull market in U.S. history. It will be Mr. Trump’s actual governing, moderated by the next U.S. Congress that will determine the direction of U.S. bond yields.
To that end, let’s take a look at the main arguments being made by those who think that a Trump presidency (I can’t lie, it still feels weird to type that) will lead to materially higher rates, with my take on why these views may be proven wrong in the fullness of time.
President-elect Trump Will Either Renegotiate or End Existing Trade Agreements
Mr. Trump campaigned on a protectionist platform, promising to re-negotiate existing trade deals such as NAFTA. If this happens, it will almost certainly fuel higher inflation, and that fear partially explains why U.S. bond yields have surged higher since the election.
In reality, Mr. Trump would have a hard time ending NAFTA. The agreement has led to extensive cross-border trade and investment between its member countries, and U.S. companies would suffer significant economic disruption if it were cancelled. There would be court cases brought by affected U.S. companies and Congress would insist on having their say. Frankly, all hell would probably break loose.
Ironically, there is plenty of research to suggest that eliminating NAFTA would not actually return jobs to the U.S. It is far more likely that U.S. companies would just shift their production to other low-cost labour markets, leaving the workers, who voted for Mr. Trump because he supported ending NAFTA, with higher prices as a reward for their loyalty (thanks to the new tariffs that would follow). Also, U.S. business investment, which has stalled since 2008 and has been repeatedly cited as the key missing ingredient in the moribund U.S. economic recovery, would decrease further as companies grew more cautious in the face of rising trade uncertainty. That would not be good for U.S. workers either.
President-elect Trump, hardly known for the consistency of the positions he advocates, has made many promises over the most recent election cycle and we know that campaign rhetoric and governing policy often do not match. That, alongside the fact that the U.S. has not withdrawn from a single trade agreement since 1866, has me thinking that NAFTA isn’t going anywhere soon.
President-elect Trump Will Initiate Massive Infrastructure Spending That Will Fuel Higher Inflation
President Trump could not initiate massive infrastructure spending without the approval of Congress who would have to pass spending bills in support of new programs. While Mr. Trump enjoys a Republican majority in the both the House of Representatives and the Senate, the House Republican tent includes 48 tea-party activists who were elected because they promised to promote government fiscal responsibility above all else.
The Republicans have 239 seats in the House of Representatives (to the Democrats 193) but the tea-party wing of the Republican party has consistently opposed spending increases since their founding in 2010 and, without their votes, the Republicans in the House don’t have the clear majority needed to pass a spending bill. And while it’s true that the House Democrats would be likely to support an infrastructure spending bill in principle, there is a good chance that it would have other elements, like tax cuts, that they would oppose.
On that note, I also doubt that the tea-partiers are going to agree to tax cuts that are funded with increased deficits either. So while it’s true that significant tax cuts would also be inflationary, they are unlikely to happen to nearly the extent that President-elect Trump promised on the campaign trail.
President-elect Trump May Try to Negotiate a U.S. Debt Default
This one really scares bond-market investors the world over.
On the campaign trail, Mr. Trump said that, if needed, he would consider “re-negotiating” the terms of U.S. debt, which is code for facilitating a strategic default. (Remember that this is a guy who personally used bankruptcy as a business tactic.) At other times, he speculated that he might just have the U.S. Treasury print more money to reduce the U.S. debt burden by devaluing the dollar (although it is the U.S. Fed, not the President, that controls the supply of that money). After listening to Fed Chair Yellen’s comments on the idea, he would probably have to appoint a new Fed Chair (and board) before this could happen.
Any further speculation by President-elect Trump about creative debt defaults will be a nightmare for any holders of U.S. treasuries (not to mention the U.S. dollar and all of the currencies that are tied to it). It’s one thing for a businessman to default on debt tied to casinos and quite another for a president to talk about doing the same with U.S. treasuries. If President-elect Trump were to even hint at this now, U.S. bond prices would likely crash, setting off a world-wide panic in the process.
Of course, even if that happened, the money that would pour out of U.S. bonds would need to go somewhere, and GoC debt is among the highest rated in the world. This would be the mother of all flights to safety and, against that backdrop, I think demand for our federal government’s debt would be more likely to rise than to fall. If this happened, it would push our bond yields, and our mortgage rates, lower.
That said, the closer Mr. Trump has gotten to the presidency, the more he has walked back from any idea that he would advocate a strategic U.S. debt default, saying recently that “the debt of this country is absolutely sacred”. This reminds us once again that campaign rhetoric and governing policy are not the same thing, to the enormous relief of bond holders everywhere.
Interestingly, if we see continued financial-market volatility over the next month, Mr. Trump’s election win might cause the Fed to forgo the December rate hike that seemed likely prior to the election. So at least at the short end of the yield curve, a Trump presidency might actually help keep rates lower for longer.
Now that he has won, my guess is that President-elect Trump’s views and comments will be tempered by a growing appreciation for the awesome responsibility and power that he is soon to hold. In the meantime, it is worth remembering Benjamin Graham’s famous observation that “in the short run, the market is a voting machine but in the long run, it is a weighing machine.” While loose talk on the campaign trail has heightened volatility and fear in financial markets now, it will be President-elect Trump’s actual policies and actions once in office that will determine whether his win signals a new bear market in bonds or an attractive buying opportunity for the bold.
Five-year GoC bond yields rose by twenty-one basis points last week, closing at 0.88% on Friday. Five-year fixed-rate mortgages are available in the 2.24% to 2.39% range, and five-year fixed-rate pre-approvals are offered at around 2.59%.
Five-year variable-rate mortgages are available in the prime minus 0.30% to prime minus 0.40% range, which translates into rates of 2.30% to 2.40% using today’s prime rate of 2.70%.
The Bottom Line: U.S. and Canadian bond yields have spiked since Mr. Trump’s election win. There is a growing consensus that a Trump presidency will fuel higher inflation rates, and if that’s true, our mortgage rates could rise in sympathy. But for the reasons outlined above, I think it is unlikely that President-elect Trump’s campaign rhetoric will transfer directly into governance, and if I’m right, the recent run up in U.S. and Canadian bond yields will be short lived. Stay tuned.