Since the election of Donald Trump, in terms of the financial markets, most attention has been on stocks. The Dow has been hitting all-time nominal highs.
The dollar price of gold has taken a big hit, but there is a sense that this won’t last. Unless we go into a deep recession without the Fed responding with more monetary inflation, then it is hard to imagine that gold will go much lower and stay down.
But while most attention is on stocks, the bond market is really the big story. Interest rates have been spiking higher. The 10-year yield, as of this writing, sits just over 2.2%. While this is still historically very low, it is higher than it has been over the last several months. Back in July, it was below 1.5%.
What is causing this short-term spike in longer-term interest rates? And will it continue with Trump taking the presidency?
To quote this Marketwatch article: “Trump’s promise of loosening regulations, cutting taxes and boosting spending to repair roads, highways and bridges has led to the higher moves in government bond yields, with traders seeing his proposals as supportive to higher economic growth and inflation, anathema to bond investors because inflation erodes the value of interest payments.”
We don’t really know if this is the reason for the higher yields. Perhaps it is a contributing reason. Still, I wonder if it is more speculation about what will happen with the Fed.
Trump is really all over the place on so many issues, and that includes monetary policy. He has said he is a low interest rate guy, but he was probably referring to his preference as a businessman. He has also been quite critical of the Fed and Janet Yellen. It is unlikely Yellen would be renominated as chair.
Trump does have some relatively hard money guys in his camp. He doesn’t exactly have Ron Paul and David Stockman on his team of advisors, but Trump is probably the closest we have seen to a hard money guy since Reagan. This doesn’t mean anything significant will actually change, but it adds to the uncertainty.
Even Trump’s VP, Mike Pence, has spoken in favor of gold. Despite my criticisms of Pence from a libertarian perspective, he is still better on many economic subjects than the average politician.
If Trump appoints inflation “hawks” to the FOMC, this could have an impact on policy. It would signal that we can expect tighter money, at least relative to what we have seen (2008-2014). Higher interest rates tend to go hand-in-hand with tighter money.
Of course, we live in bizarre economic times. The Fed has had a tight money policy for the last two years, yet interest rates have stayed low. The massive pile of excess reserves has helped to keep rates down with the tight money.
In addition, if we have a recession, we should expect long-term rates to go down again. There will be a flight to safety, which includes government bonds for many investors, assuming that imminent price inflation does not seem to be a threat.
I don’t think a Trump presidency is going to matter that much, particularly in the short run. The uncertainty can add to volatility, but it is not likely to significantly change monetary policy any time soon.
From a libertarian perspective, and a growth perspective, we should hope for higher interest rates. This is the only thing that can ultimately impose limits on government spending. The only other thing that can impose limits is public opinion, which doesn’t seem to care much right now.
Higher interest rates can ultimately force a reduction in spending in order to limit the new debt issues. This means that Congress would have to raise taxes or cut spending, and raising taxes is not likely on the table right now.
The economy needs higher interest rates and lower government spending. The higher rates will encourage more savings, which is needed for economic growth. A reduction in government spending is needed, as virtually all government spending is a misallocation of resources, as capital is expended on things that are not of the highest priority for consumers.
It is interesting that stock markets are hitting new highs at this time, because higher rates could ultimately hurt stocks. If there are higher rates, it attracts risk-averse investors searching for yield. They do not need to gamble in the stock market in search for yield if yields are higher for bonds.
Trump can impact the spending side of things, but he hasn’t really proposed any significant cuts. The only hope might be for a reduction in war operations in the Middle East.
The biggest factor for the economy in the coming years is Fed policy. Trump can have an impact based on who he appoints to the FOMC open positions. But even if he appoints inflation hawks, it may not matter that much in the next year or so.
My biggest fear with a Trump presidency is that a major recession hits a couple of years into it. It is possible there could be a clean sweep of Congress and the presidency by the Democrats in 2020. This would be at a time when people might be desperate for government solutions to the economic problems.
My hope is that there will be a downturn soon. Trump can blame Obama, even though he should be blaming Yellen and Bernanke the most. You can also blame the Congress for allowing the huge spending.
I expect a recession sooner rather than later. Maybe the spike in interest rates this past week is an early indicator. I am more bearish on stocks than bonds in the near term though.