Talking about last week or this week seems like an exercise in futility. It seems like the calm before the storm and that the economic releases, Fed member comments, global interest rate disparity, OPEC declarations, last ditch efforts from the current administration, etc. have limited impact. Simply, all focus lies on Friday when Mr. Trump becomes President Trump. Friday marks a new beginning and different approach to U.S. politics. One might say we are shifting from an era of politically motivated decision-making to a more business-like approach. It makes no difference where you stand politically or whether you support or dislike the platform. Either way, judging by the campaign promises and the cabinet nominees, we are in for changes which include potential influential market transformations: a move to energy independence, a shifting Fed member composition, a locked-in conservative supreme court, an American-friendly business philosophy, de-regulation and tax-incentivized adjustments for corporations and individuals.
The bond market has calmed down in anticipation of what really amounts to a lot of unknown. How many of these campaign promises will come to fruition? How receptive will congress be with their support? How long will it take these changes to filter through and affect the economy? The end of last year pushed yields dramatically up in hope. Since the beginning of the year, we are experiencing a subsiding of the excitement. The reality is, even under the best conditions, it will take years for changes to take shape. The bond market players should understand better than most that this is not a game of moments and instant conversions but formed and measured over years.
When it was all said and done and 2016 came to an end, 2017 arrived with interest rates narrowly higher. The long bond was 5bp higher at 3.06% versus 3.01% at the start of the year.
It can be surmised that rates ended the year slightly higher based exclusively on our national election. There was no significant difference in economic data, inflation, wages or any other economic identifier but the significant difference appeared in the change from a nation run by career political figures to the incoming ideal that it will now be run by business people. The take-away seems very evident: nothing will be the same. Change, whether deemed positive or negative, is on the way. The 2017 economic realm certainly stands to be transformed.
Since the election, the betting table has flipped. An emergence of Treasury future contract short-selling is partly responsible for the hasty year-end interest rate reversal. The selling of 10yr Treasury future contracts escalated. Now it appears a more conservative bet sees the selling of 5yr Treasury futures. These are bets that both economic growth and inflation will push Treasury prices down and yields up in 2017. (Source: Bloomberg LP)
OPEC seems to have a quarterly decree for cutting production and the most recent proclamation gave oil another price boost. Typically, this play is dismissed when one of the players decides it’s not worth losing market share; however, a greater force is shaping the energy world. The change here is that the U.S. is poised to be a net “exporter” of oil rather than “importer”. Much is set to play out in 2017 and the upcoming years.
The U.S. central bank, commonly referred to as the Fed, has been run by academics. It can be assumed that 2 slots to be immediately filled by Trump will go to business individuals. Chair Janet Yellen’s term will end in February, 2018. Another immediate impact will occur with the Supreme-court appointee where Trump has pledged to stick with a list of conservative nominees.
Looming over all these domestic changes is another enormously impactful change: the euro-zone and its survival or at least its composition. Germany’s vice chancellor just recently said that a euro-zone break-up is no longer inconceivable. The United Kingdom started the reality. Upcoming elections in France and the Netherlands have similar tones to the U.S. election with the “out with the old, in with the new” mantra.
It is always difficult to prognosticate but one thing seems certain entering 2017. People and nations are clamoring for change and this year can be expected to deliver.
Twas the week before Christmas, when all through the market
Not any data releases were stirring, at least enough to spark it.
The ballots were counted by the chimney with care,
In hopes of stimulating the economy with more than a prayer.
The investors were nestled all snug with their money,
While visions of higher yields danced and portfolios looked sunny.
And Yellin with her committee, and I in my analysis gift wrap,
Had just settled our brains for the Christmas break’s nap.
When out around the globe there arose a clatter,
We sprang from our chairs as rates were a scatter.
Away to the U.S. money flew in like a flash,
Keeping the headwinds on rates and mattresses stuffed with cash.
The moon on the breast of new higher rates,
Tore open the height of equities and asset-class weights.
When, what to my wondering eyes should appear,
The dollar is screaming, corporate profits do fear.
When an out-spoken driver, so lively and quick,
Investors knew in a moment that Trump was the pick.
More rapid than eagles his policies they came,
And he whistled, and shouted, and announced them by name.
Now, McGahn! Now, Mattis! Now, Priebus and McMahon!
On, Puzder! On, Price! On, Flynn and Bannon!
To the top of a strong dollar! To the stock market bull,
Now dash away! Dash advantage away! Dash away with yields getting full.
As dry leaves that before the wild hurricane fly,
When they met with an election, red states were high.
So up to the house, the senate, the oval office they flew,
With a sleigh full of republicans, and Trump too.
An then, in a twinkling, I heard on the hill
The prancing and pawing of each appointment to fill.
As I drew in my head, and was turning around,
Down the chimney Trump is coming with a bound.
He is dressed with promises, from his head to his foot,
And his policies may make some regulations go caput.
A bundle of changes he has flung on his back,
And he brings stimulus, trying to lift economic slack.
His eyes how they twinkled! His message so merry!
His campaign was like roses, to some it is scary.
Changes to the Supreme Court pending picks,
The Fed to change leadership, part of the mix.
The Trump of a pick held tight in America’s teeth,
And the changes encircled like a Christmas wreath.
He has a bold plan to make America great,
Pre-inauguration market results seemed thrilled with the fate.
The headwinds still swirl, so caution ahead with muddy clarity,
Central bank direction, the dollar and interest rate disparity.
Stimulus takes time to affect GDP,
Rates may inch up but slow like the growth of a Christmas tree.
Don’t sway from the portfolio plan, keep asset-class smarts,
Cash flow, income and stated maturities for healthy investor hearts.
As we end the year with optimism at a peak,
“Merry Christmas to all, and to all a good week!”
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.