Hi I am Arjun Parthasarathy speaking and this podcast is on “Trump and End of Bonds and Beginning of Equity”
Trump win in US elections has resulted in a global bond sell off and a sharp rally in equities. US equity indices closed at record highs on the 23rd of November while US ten year treasury yields closed at one year highs. The reason for equity rally and bond sell off is expectations that the Trump administration would fiscally pump prime the economy even as Fed turns neutral on policy.
The world has seen an unprecedented period of ultra low interest rates since the 2008 financial crisis, with central banks from Fed to ECB pulling down policy rates to zero and below. Central banks have expanded their balance sheets by 4x
since 2008 through QE, pumping in USD trillions into their economies. The large amount of liquidity infusion was required to keep economies from sinking as both consumers and governments stopped spending due to high leverage. Government’s did spend initially, just after the crisis, but after a couple of years, debt levels became too high for sustainability of spending.
Bond markets have had an eight year period of declining to low interest rates, with brief period of spurts in yields. Low inflation expectations coupled with monetary easing and fiscal austerity have kept rates at record lows. However, this could be coming to an end if Trump can actually deliver on fiscal pump priming.
The UK government too has shown inclination to expand its budget to push up economic growth. ECB has been calling for governments to spend to help its task of fighting low inflation.
Governments starting to expand budgets to spend would allow central banks to commence normalizing policy and bond yields can move up gradually from ultra low levels. If government spending works, economic growth could get back on track with rising inflation expectations and that would be highly positive for equities.
Is the post Trump market rally in equities a sign of the future? If it is then there could be a sustained uptrend in equities even as interest rates start to normalize. However, given the high debt levels of economies including the US, it remains to be seen if government’s do have the ability to spend.
Central banks cannot expand balance sheets indefinitely and they cannot keep rates at close to zero percent for long periods of time. Long periods of low economic growth is highly negative for economies as well as markets. Hence fiscal expansion is seen as desirable at this point of time.
Markets live on expectations and market trends reflect the expectations. The rally in global equities and sell off in bonds do suggest expectations of an equity boom and a bond bust.
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