Donald Trump’s U.S. presidential election win and Republican control of the Senate, both projected by major media outlets, has spurred notable reaction in the financial markets. We discuss some of the highlights and our views over what the market may be missing in some cases.

 

 

The Yield Curve Steepened

 

The most notable market action occurred with U.S. Treasury yields. Long-end (10- to 30-year Treasurys) yields are sharply higher and the yield curve has steepened. We think this makes sense given Trump’s stance on tariffs, immigration and taxes. Generally, Trump’s proposed policies could add to the government’s debt, increase inflation and lower growth.  While we think investors generally consider Treasurys the “safest” investment, they are certainly not invincible.

 

We think Trump’s proposed policies during his campaign could cause the U.S. government’s debt load to balloon to more than 170% of economic output in the next 10 years from about 120% now. Over the long-term, a lack of fiscal discipline could lead to a rise in Treasury yields.

 

The Federal Reserve embarked on an interest rate cutting regime in mid-September, taking the short-term Fed Funds rate down 50 basis points with expectations for additional cuts. Meanwhile, longer term rates have moved meaningfully higher since that time. Taken together, this steepening reflects both Fed action and investor views towards government debt on the long run and the term premium investors expect. Now that yields are higher and the curve is positively sloped, longer term bonds have become more attractive than they were previously. 

 

 

U.S. Stocks Rose

 

Large-cap U.S. equities rose this morning, around 2% for the S&P 500 Index and Nasdaq. The small cap Russell 2000 Index topped 4%. We think the sizeable increase in U.S. equities is consistent with the common narrative that Trump is positive for business. But that is somewhat at odds with the prospect of higher inflation and lower economic growth.

 

We think there are several possible explanations for this apparent conflict in thinking:

 

• The market doesn’t believe he is going to follow through on his immigration and tariff plans.

 

• And/or the market believes if he tries to implement those plans, the market will react very negatively at that time, and Trump could react by reversing those decisions.

 

If neither of those two is true, then the uptick in U.S. equity markets will be short-lived.

 

 

Potential for Less Regulation May Be Driving Equities

 

Another possible explanation for the dramatic rise in equities is that both regulation and taxes will be lower. The regulation argument is one we generally agree with, and it will certainly benefit a subset of equities, such as the financials sector. On the tax side, we don’t expect that the extension of the previous Trump tax cuts stimulate the economy, as those cuts are already in place. Thus, the tax cut argument would need to result meaningful additional tax cuts, beyond simply extending the previous ones set to expire.  This is limited in our view, particularly in light of high debt levels and the possible effect on Treasury yields.

 

Equity investors need to consider the balance of headwinds and tailwinds from expected policies, and how companies are likely to adapt. Higher interest rates could weigh on the valuation of longer duration growth equities, as we have observed historically. Further, inflationary pressures from increased labor and input costs may be an additional headwind to profit margins. However, the maintenance and potential decrease of taxes and deregulation may boost corporate investment and consumer spending, which would be a tailwind to equity returns.

 

 

The Market’s Inflation View Hasn’t Moved Much

 

The break-even rate, or the yield difference between Treasury inflation-protected securities (TIPS) and Treasurys of the same maturity, has moved only somewhat higher. This means that the market isn’t concerned about Trump policies igniting inflation. We think the market may be missing something here, so TIPS could be attractive at the moment.

 

 

The Expiration of the Debt Ceiling Suspension Is Approaching

Debt levels will once again come into focus as the U.S. will reach the debt ceiling in the coming months. How this gets discussed and negotiated will be an early indication of whether spending restraint will be shown. In June 2023, the government following a series of difficult negotiation agreed to suspend the debt limit until January 1, 2025, so just a couple months from now. Still, the Treasury department historically has found ways to continue to pay bills without increasing debt for months after debt ceiling deadlines. Even if Republicans continue control the U.S. House, which isn’t clear yet, Republican budget hawks could leverage the opportunity to force Trump to take a hard look at how his policies could increase the deficit. Markets could become volatile if negotiations stall and worries about default mount.

 

 

China’s Equities Haven’t Budged Much

 

The Shanghai Composite has remained flat, possibly indicating little fear that U.S. tariffs will significantly impact on China’s economy. However, there has been encouraging news of measures by the Chinese government to stimulate the economy, which may offset concerns about tariffs potentially damaging exports to the U.S.

 

 

Conclusion: Potentially Changing Policies for Investors to Track

 

We have favored U.S. equities on economic strength and consumer resilience. However, we have noted election-induced pressures because of tariffs or immigration policies, including disruptions from the conflict in the Middle East. Of course, campaign proposals are often implemented with different details than promised on the campaign trail, if they become policy at all. Today’s market reaction only represents today’s information, and we think investors will be best served tracking how Trump’s key policies are implemented and how they could impact inflation, the economy and the federal debt burden longer term.