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The Real Trump Trade: Get Out of Treasurys

Posted by hkarner - 4. November 2016

Date: 03-11-2016
Source: The Wall Street Journal

Economic policies are likely to be inflationary, the opposite of what investors’ likely bets assume

Republican presidential nominee Donald Trump addresses supporters at a rally in Miami on Wednesday.

Investors think they understand what happens in markets if Donald Trump becomes president. But there is a deep flaw in that thinking, and it may offer a great trading opportunity.

The basic Trump Trade is simple enough. It is a “risk off” trade, plus a bet against the Mexican peso. It counts on higher volatility, higher gold prices, lower shares, lower bond yields, a weaker dollar against developed markets—even Brexit-struck sterling—and a stronger greenback against emerging markets.

The problem: If Mr. Trump does even part of what he has promised, it will be inflationary, the very opposite of what those risk-off bets assume.

Since the FBI director’s explosive letter on Friday, Mr. Trump has jumped in the polls and his chances of winning have risen to almost 27% on the Betfair betting market.

A week ago, Betfair put his chance at 14.5%. What have the markets done? Over the same period, the S&P 500 is down 2.5%, and the VIX index of implied volatility has risen from 13 to 19.3.

The reverse also appears true. The University of Michigan’s Justin Wolfers and Eric Zitzewitz of Dartmouth College analyzed the anti-Trump trade during and immediately after Mr. Trump’s poor performance in the first presidential debate.

BETTING ON ELECTION? GO TO MEXICO

ETFs

An exchange-traded fund that tracks Mexican companies has been notching some blockbuster trading days as U.S. election uncertainty roils markets. The $1.2 billion iShares MSCI Mexico Capped ETF, which has been around since 1996, traded 10.9 million shares on Tuesday, its fourthbiggest day ever. The ETF is down 4.2% this month, falling as polls have showed Republican nominee Donald Trump catching up in the polls. A win by Mr. Trump has been viewed by investors as bad for Mexico, since he has spoken of building a wall between the two countries and said he may make changes to the North American Free Trade Agreement.

Peso

Wall Street’s market proxy for the U.S. presidential election is once again showing Republican nominee Donald Trump’s chances of winning are on the rise. The dollar climbed 0.97% against the peso Wednesday, extending a rise to 19.37 pesos per dollar versus 18.85 last Thursday, according to FactSet. The dollar was last at these levels about the beginning of October. A win by Mr. Trump, who has promised to build a wall between the U.S. and Mexico and said he may revise the North American Free Trade Agreement, has been interpreted as bad for the peso by analysts, causing the currency to fall as his chances have risen.

Extrapolating from the price moves as traders bet on Hillary Clinton winning, they predicted that the S&P 500 would be 12% higher under President Clinton than President The Donald, the VIX would be 15% to 30% lower, 10-year Treasury yields would be 0.25 percentage point higher and oil would be $4 a barrel higher.

There are good reasons for markets to be wary of Mr. Trump. Abandoning a 30-year shift toward free trade and reversing U.S. foreign policy would introduce major global instabilities, with unknown—and potentially scary—consequences. His economic policy is incoherent, at best. And having a leader who treats truth so carelessly makes it hard to work out what he might do.

Mr. Trump’s plan for the economy may not add up, but it is clear: more borrowing, more spending, lower taxes. If he wins, he will probably have Republicans in control of Congress able to push his plans through. But we know that such an approach is inflationary and means more government debt, both of which should push up bond yields.

His criticism of Federal Reserve Chairwoman Janet Yellen suggests more politicization of the Fed, too, which again is bad for bond-market confidence.

Even the short-term danger that Mr. Trump trashes trade would mean higher prices, which again are bad for bond yields.

At the moment, the risk of a trade war hurting the economy is at the forefront of market analysis, along with the broad uncertainty Mr. Trump would bring about U.S. policies on almost everything.

But whatever a President Trump would do, we can be pretty sure that the direction of travel on the economy would be toward more borrowing and lower taxes. He might or might not start a damaging trade war with China or break up the North American Free Trade Agreement, but he almost certainly would cut taxes and boost the budget deficit and government debt.

The danger is that market muscle memory is kicking in, with a flight to Treasurys purely because that is what investors do when they are unsure.

Such simple-minded trades can defy logic, as in the 2011 debt-ceiling crisis when investors bought Treasurys because they were worried that the U.S. government might default…on Treasurys.

There is no law that says logic has to triumph in the markets any more than in political rhetoric, but there is a decent chance that a sharp fall in bond yields if Mr. Trump wins would be a good opportunity to renew bets on inflation, by dumping Treasurys in favor of inflation-linked TIPS.

The brave—and Trump true believers—could be tempted to buy a postelection dip in stocks, too, hoping that promised corporate-tax cuts combined with fiscal stimulus will more than outweigh any losses from trade barriers. But the safer trade is on inflation, and stocks provide poor protection against that.

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