The Market Hangover
Sobering up after the Trump Trade Ho-Down
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Last week was not a good week to be a no-coiner. Bitcoin gained 20% while SPX, RTY and NDX all sold off.
The major indices are now only marginally up post-election.
We worked off some of the animal spirits that emerged in the immediate aftermath of the election, but not all of them. Many of the most apparent Trump trades are still up big.
We are seeing a bifurcated market emerge, in which “Trump Beta” has largely held onto its gains while the broader markets have not.
Trump, Tariffs, and Inflation Expectations
The US 10-year yield is back near its’ summer highs.
I see many people arguing that this is due to rising inflation expectations under Trump. Let’s examine that.
5-year inflation expectations are up about 30bps off their September floor.
1-year inflation expectations haven’t changed much at all, and are down, if anything.
I don’t think you can argue that inflation expectations have caused the 10-year yield to rise 80bps. The data just doesn’t support it.
So what’s happening?
Growth, Rates, and Forex
The dollar has rocketed to its highs for the year. It now sits at the highs of its 2-year range.
Forex is very complicated and I’m far from an expert on it, but I’ll weigh in a little despite all that.
You can think of the price of the dollar as reflecting demand for the currency and the yield on a bond reflecting the market for the bonds. In the case of the dollar, if there is more demand for the dollar, the price goes up. Same for bonds, higher demand drives the price up, and the yield lower.
So we are seeing demand for the dollar rise and demand for US bonds fall.
Why the dollar might be rising:
Demand to transact in the currency, IE trade flows. Expectations might be that Trump will make the US even more of a trade powerhouse, and markets might front-run those flows.
Demand for dollar denominated assets. When a foreigner buys an asset denominated in dollars, they must first exchange their currency for dollars in order to buy the asset.
Demand for dollar reserves. Demand to hold reserves in dollars.
Why bonds might be falling:
The market has found other, more promising places to put their money at current yields. Yields will fall until those flows reach equilibrium. For instance, if equities are more appealing than bonds then bonds will sell off until their yield is roughly as appealing as investors’ perception of equity returns.
The market has realized that US fiscal policy is a one-way train, and they are front running bond supply increases.
The combination of a strong dollar, and high real bond yields bodes well for the US economy. It means investors are pricing a strong United States.
Powell Speech
Powell gave a speech last week where he seemed to lay the groundwork for a Fed pause.
A lot of commentators attributed the sell-off in equities last week to these comments, but I’m skeptical.
The curve barely moved, pricing a December cut down to around 50% from 80%, but not changing much beyond that.
The Equity Market Front-Run
When you add everything up, I think we just saw a market freak-out last week that holds much more signal than noise.
I am not in agreement with the commentators out there who are comparing this to 1987 or any other analogue and predicting a crash.
In fact, there’s probably a tactical trade this week in going long equities. I haven’t decided if I’m going to pull the trigger.
I do, however, think that a lot of the easy juice in equities has been squeezed so far. One of the hallmarks of the first Trump administration was a bullish but volatile equity market. We are overdue for a period of consolidation, and with everyone expecting a Santa rally, what would be more fitting than violent chop?
Equities have been pretty aggressively pumping since the late 2022 lows, correctly anticipating a marked rebound in the economy. They have, in essence, front run the goldilocks situation we appear to be in.
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