By Roger J Kerr
Some of the bond market super gurus in the US (e.g. Bill Gross) are starting to question whether the increase in long-term interest rates we have seen since the stunning Trump Presidential Election victory four weeks ago is sustainable going forward.
The US 10-year Treasury Bond yield jumped from 1.80% to 2.40% on the expectation of higher US inflation from the Trumponomics infrastructure spending and potential tariffs on imported consumer goods.
Whilst I see the infrastructure improvement policies going ahead and being positive for US economic growth and inflation, there remains a risk that President-Elect Trump will backslide somewhat on the trade side when the economic/financial realities of US manufacturing costs and prices versus Asian manufacturing sinks in.
However, a lower unemployment rate, rising wages and rising gasoline/freight prices in the US all point to rising inflation in 2017.
The Federal Reserve will deliver their assessment of these inflation forces and trends next week.
The only scenario I can see for US bond yields to correct back down to 2.10% area in the short-term would be a “No” vote in the Italian constitutional referendum today and global investors embarking on a “flight to quality” (i.e. buying bonds) due to heightened European political risks.
In the absence of safe-harbour bond buying in a risk-off market mood, the economic trends in the US still suggest higher long-term interest rate yields as both inflation and short-term interest rates increase in 2017.
Over recent weeks since the US Presidential Election the interest rate markets have priced expected future US inflation considerably higher to 2.1% from 1.70%.
The chart below is derived from the nominal five-year bond yields commencing in five years’ time and inflation-index bond securities for the same period.
The higher inflation outlook is pushing the US Treasury Bond yields and our term swap interest rates higher.
They can move higher still if inflation continues to increase.
Daily swap rates
Select chart tabs
Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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