Benjamin Streed: "A bit of déja vu"

by Benjamin Streed, CFA, Raymond James

In the financial markets, taking a long-term perspective is paramount when looking at asset performance, yield levels or other metrics when trying to get an understanding of where we’ve been, where we are and where we could be headed. Case in point; financial markets around the globe have seen tremendous volatility in the wake of the US presidential election. 5, 10 and 30-year Treasury yields have increased by approximately 44, 46 and 38 basis points (bp) respectively since November 8th and the 2s30s spread, a measure of the steepness of the yield curve, has risen by nearly 20bp. Although yields are up substantially since the lows set in July, you don’t have to look back very far to see we’ve already been here before, a bit of déjà vu. It’s easy to forget that we’ve been here before, earlier this year we saw these exact same yields.

One thing that has changed: much of the move higher in yield has been the result of the “reflation” trade, meaning that markets are now pricing in a large expected increase in inflation in the coming years. Another way to track this, 5-year inflation expectations beginning in 5-years (the 5y5y inflation rate) now stands at nearly 2.50%, having been as low as 1.79% in February. This is critical as the Fed’s target rate is 2.00%, and the market is now assuming that inflation will be above the Fed’s target for a number of years, well beyond the end of the first, or second (potential) Trump presidency. This of course begs the question, have we come too far too fast? This election cycle has been unique, to say the least. There’s a tremendous amount of policy uncertainty at the moment, Trump won’t take office until January and the markets are trying their best to sort it out, but it’s going to take more than a few weeks. One man was elected (Donald Trump) to one executive office (US President), in one country (United States) and all of a sudden the entire world is on notice, and the game has changed for everyone, everywhere. The market’s not-so-subtle reaction is an attempt to reprice everything: inflation, deficit spending, infrastructure, tax cuts (personal and corporate), international trade, GDP growth, job creation and even the forward path of monetary and fiscal policy. Six, twelve, even 24 months from now we could still be in a state of policy uncertainty, so this volatility could continue. Perhaps it would be best to catch our collective breath and take a step back for a moment. In the meantime, have a wonderful Thanksgiving!

 

Copyright © Raymond James

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