by Dr. Brian Jacobsen, CFA, CFP, Wells Fargo Asset Management
Treasury yields have torn higher since Election Day, and there seem to be three interrelated theories suggesting why:
- The idea that potential tax cuts and infrastructure spending could increase the government’s budget deficit. The prospect of more Treasury supply coming down the pipeline with deficit spending could drive up yields.
- If the economy already has low unemployment, a pick-up in the pace of growth could also bring about higher inflation.
- President-elect Trump has said he’d like to see interest rates move higher. With two vacancies on the Federal Reserve (Fed) board, he could appoint hawkish members. That could mean a faster pace of rate hikes by the Fed.
Another reason sometimes given for the move up in yields (unrelated to the above factors), pertains to default risk. While on the campaign trail, candidate Trump mentioned being willing to renegotiate the national debt. This was a vague and perhaps unintentional reference to the prospect of defaulting on U.S. debt. After the election, the cost of insuring Treasury securities against default through credit default swaps (CDS) did jump, so this could be a contributing factor.
If Mr. Trump’s election did affect Treasuries, this would be reminiscent of the 2013 Taper Tantrum, which was triggered by a speech from then-Fed Chairman Ben Bernanke, in which he hinted the Fed would slow its pace of asset purchases.
During the Taper Tantrum—which lasted from May to October 2013—the 10-year Treasury yield rose from 1.93% to 2.13% the first week, but then moved markedly higher, hitting 3.0% three months after Chairman Bernanke’s speech. It’s still early, but the trajectory of Treasuries in the wake of Mr. Trump’s election has followed a similar pattern with yields rising. A key difference between the two episodes can be seen in the market for Treasury-Inflation Protected Securities (TIPS). The minimum rate of inflation that must prevail for TIPS to return more over their lifetime than what’s earned on non-inflation protected Treasuries fell from 2.28% in May 2013 to below 2.0% within a month. In the first few days after Donald Trump’s election, this breakeven rate of inflation shot up from 1.73% to 1.83%.
Qualitatively, the Taper Tantrum and the potential effects of Mr. Trump’s election are different. The Taper Tantrum seemed to be driven primarily by the prospect of a less accommodative Federal Reserve. The Trump-effect is more multi-faceted, driven by the outlook for the Fed; an increase in inflation expectations; a change in the outlook for growth; and perhaps even a small increase in default risk.
Despite these differences, there are still good lessons from the Taper Tantrum that can be applied to today’s market moves. The first is that all investing—yes, all, including investing in Treasury securities—entails risk. The second, however, is that diversification and patience are investing virtues. While Treasuries have sold-off, equities have risen. Also, the Taper Tantrum of 2013 saw higher-yielding corporate bonds sell off less and recover faster than Treasury securities. Rising rates don’t have to be universally bad for fixed income markets, especially if the increase in yields is coupled with an improvement in the growth outlook, which is typically good for corporate and high-yield fixed income.
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