FIXED INCOME MONTHLY

Surprising election result accelerates trends

Nov 16, 2016 / By Jeffrey Rosenberg

Fixed income highlights

  • The forgotten men and women of our country will be forgotten no longer.” Arguably the turnabout from risk-off to risk-on following the surprising election result can be attributed to Donald Trump’s magnanimous acceptance speech. Yet the historical usage of this phrase has two meanings — which meaning does he imply? Like that question, which President Trump emerges — the populist or the pragmatist — holds great meaning for the investment outlook. The initial bond market reaction of higher longer-term rates highlights a reflationary expectation, both from a steeper yield curve and higher “breakeven” inflation expectations from Treasury Inflation-Protected Securities (TIPS) prices.
  • The Republican sweep scenario. Only a few weeks before the election, financial markets debated the implications of a Democratic sweep. Part of the strong market reaction to the election was the low likelihood market participants put not just on a Trump win but also on full Republican control. Though Trump is clearly no ordinary Republican, the reflationary theme in bond prices reflects expectations for rising fiscal policy support to ease the burden on monetary policy. And where monetary policy has manifestly failed to create inflation, the cavalry of fiscal policy potential under a Republican-controlled government raises the odds of reflationary success.
  • Some like it hot. The near-term, post-election implications for monetary policy appear unchanged. Absent significant market dislocation between now and the December meeting, the Federal Reserve likely raises rates by 25 basis points and continues to signal its go-slow approach. This Fed wants to get behind the curve and run the economy “hot.” The market reaction to the election implies increasing odds it may be successful. The longer-run implications of a Trump Presidency on Fed policy remain unclear and a source of significant uncertainty given his criticisms of Fed policy coupled with several opportunities to alter the makeup of Fed governance.

Strategy and outlook

The immediate implication of the surprising election result accelerates trends that pre-dated the outcome. Namely, the anticipated shift towards fiscal policy that can alleviate the heavy burden on monetary policy. That leads to higher rates and a steeper curve as the Fed continues a go-slow approach to normalization to encourage a go-fast economy, where rising inflation expectations account for a greater share of interest rate increases. That keeps TIPS and steepeners as preferred strategies with high-quality carry in investment grade. The potential populism in future policy, however, creates a bit more downside risk to our preference for emerging markets, leading to a more cautious stance for that sector.

Jeffrey Rosenberg
Chief Fixed Income Strategist
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views on sector allocation within fixed income, currencies and commodities.
Jeffrey Rosenberg
Chief Fixed Income Strategist
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views on sector allocation within fixed income, currencies and commodities.