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Bond traders are betting on Trump. Investors should stay on the sidelines.
The upcoming U.S. presidential election has become one of the most surprising in the nation’s history with President Biden withdrawing his candidacy and endorsing Vice President Kamala Harris as his successor. Key members of the Democratic Party are now coalescing around her nomination .
Biden’s decision was widely anticipated after his poor debate performance raised questions about his fitness to serve. The latest AP-NORC poll revealed that two-thirds of Democrats believed Biden should withdraw . As of mid-July, betting markets assigned more than a 50 percent probability that Harris would replace him.
The latest surveys show Harris would do somewhat better against Trump than Biden, but not enough to alter the election outcome.
Meanwhile, bond traders have been positioning for a Trump victory in November in which Republicans could gain control of both houses of Congress. The so-called “Trump trade ” — wagers that bond traders are making based on the anticipation that a Trump win will bring tax cuts and higher tariffs — has gained momentum this month, according to Bloomberg.
Traders believe these policies will boost inflation and bond yields. The principal manifestation is a steepening of the Treasury yield curve in which yields on longer-dated instruments have fallen less than those on short-dated instruments as inflation has come down.
This assessment is consistent with a recent Wall Street Journal survey in which most of the economists that participated expected inflation to be higher under another Trump term than a Biden term.
According to the Committee for a Responsible Federal Budget, the main reasons cited are that Trump is calling for much higher tariff increases, and he is likely to extend the Tax Cut and Jobs Act of 2017 . The latter could reduce federal revenues by $4-$5 trillion over the next decade.
The stock market, by comparison, has yet to react to the latest political developments. Equity investors instead are fixated on prospects that the Federal Reserve will lower interest rates at the September Federal Open Market Committee meeting amid signs that the job market is softening.
They are also aware of what happened following Trump’s surprise win in the 2016 election. The stock market plummeted initially on the news, but it subsequently went on to set a record high in 2017 in anticipation of tax cuts.
Since then, federal debt outstanding held by the public has snowballed in the wake of the COVID-19 pandemic, and it is now on a trajectory to surpass the record high of 105 percent of GDP at the end of World War II. Consequently, this prospect could keep bond yields elevated even if the Fed eases monetary policy.
Although investors are well aware of the fiscal policies of both Trump and Biden, they have little to guide them about the policies of Biden’s successor. However, the presumption is that Kamala Harris will continue the policies of the Biden administration.
Given the macroeconomic uncertainties, Goldman Sachs’ economists suggest that equity investors should focus on how a Trump win could lead to the deregulation of sectors such as banking, healthcare and the oil industry.
Within the energy sector, for example, they see liquefied natural gas (LNG) as a clear winner assuming the current ban on exports to non-Free Trade Agreement countries is lifted. The oil sector also stands to benefit if leases on federal land and offshore energy development are expanded.
My assessment is that investors should not alter their investment portfolios significantly. Stock market returns over the long term are primarily driven by the performance of the U.S. economy, and politics play a limited role most of the time.
The principal outlier in the post-war era was the election of Ronald Reagan in 1980. It marked an end to the stagflation of the 1970s and ushered in a period of increased economic growth, low inflation and strong equity market returns. Key policy changes included corporate and personal tax cuts, deregulation of businesses and backing for the Federal Reserve to bring inflation under control.
Following Trump’s election eight years ago, many investors viewed his victory as a potential “game-changer” because some of his economic policies were similar to Reagan’s. However, investors subsequently learned that there were considerable differences between “Reaganomics” and “Trumponomics” especially relating to international policies.
Looking back on what ensued, it is hard to differentiate the economy’s performance in the Trump era from the Obama years and Biden’s presidency. Over the past 25 years, the trend growth rate of real GDP has been about 2 percent per annum — or more than a full percentage point below the trend in the second half of the 20th century. The deceleration in economic growth is mainly the result of slower U.S. population growth.
The biggest deviations from the trend during this period were the 2008 financial crisis and the onset of the COVID-19 pandemic in 2020. Whereas the first shock was accompanied by disinflation, the pandemic transmitted higher inflation worldwide via supply chain disruptions.
Accordingly, people should be wary when politicians contend they can alter the economy’s trajectory materially.
This perspective is shared in a recent J.P. Morgan Wealth Management webcast about how the presidential election could impact investment portfolios . The firm advises clients that, “Although elections may be stressful, you’ll likely be better off if you can avoid letting the associated emotions derail you long-term financial plans.”
For this reason, I believe investors should park their politics at the door to be objective when making strategic investment decisions.
Nicholas Sargen, Ph.D., is an economic consultant for Fort Washington Investment Advisors and is affiliated with the University of Virginia’s Darden School of Business. He has authored three books including “Investing in the Trump Era: How Economic Policies Impact Financial Markets.”