(Bloomberg) — The growing prospect of a Trump presidential victory makes steeper interest rates an attractive bet, as growth would slow and inflation accelerate in such a scenario, according to Morgan Stanley.
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The US presidential debate has reinforced the possibility of Donald Trump’s re-election, and this will increase attention on the former president’s immigration and tariff policies, the bank’s strategists wrote in a note from the June 29. Bond traders are bracing for a similar outcome, as the discount on 10-year bonds to two-year securities declined last week to its highest level since January.
“There has been a clear relative change in the odds of President Trump winning over President Biden” since the debate, Morgan Stanley strategists including Matthew Hornbach and Guneet Dhingra wrote in the note. “The dramatic shift in odds favoring President Trump could be a unique catalyst that makes curve steepeners attractive. »
The recalibration of bets could complicate the outlook for the U.S. government bond market after it ended a two-month winning streak last week. Traders are pricing in the risk of slower growth and faster inflation as Trump has pledged to deport undocumented immigrants and increased threats of higher tariffs against China.
“The market now faces increasing odds of changes in immigration and tariff policies in an economy where growth is already slowing, making the market more likely” to price in further tariff rate cuts. American interest, write the strategists. “The higher prospects of a Republican victory, amid an increasing focus on deficits, could put upward pressure on premiums in the long term. »
Strategists recommended adding two-year/20-year steepening rates in Treasuries.
Higher tariffs and the potential deportation of migrants would both be negative for U.S. economic growth, Morgan Stanley analysts said in a presentation last month. The hit to the economy would likely encourage the Federal Reserve to cut interest rates, reducing short-term yields.
The Congressional Budget Office has estimated that immigration would generate a $7 trillion increase in gross domestic product over the next decade.
U.S. Treasury Secretary Janet Yellen said last month that Trump’s proposed tariffs would raise costs for consumers and weigh on U.S. businesses. Faster inflation would be bad news for longer-dated debt because it would reduce the value of their fixed payments over time.
The outcome of the presidential debate sparked a wave of calls from analysts about how to position themselves for a Trump victory. For its part, Barclays Plc recommends that investors purchase inflation hedges in the US Treasury market.
Naokazu Koshimizu of Nomura Securities Co. believes the Trump administration favors fiscal expansion and a weak dollar. This, combined with the preference for a dovish Federal Reserve chair, would lead to a steepening of the US yield curve.
“It would be difficult to cover the fiscal expansion in the case of a Trump administration with additional tariffs alone, and the possibility of issuing more bonds will increase,” Nomura’s senior rates strategist wrote in Monday a note. “If inflation starts to rise again and the Fed’s policy rate remains high, higher interest payments should also lead to a wider budget deficit.”
(Updated with Morgan Stanley economists’ views in seventh paragraph, CBO estimates in eighth paragraph, and context in ninth paragraph. An earlier version of this article was corrected to show that the U.S. yield curve has become less inverted, the discount on 10-year bond yields to two-year notes has narrowed the most since January, and the trade recommendation has been made.)
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