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The rise in risk aversion that followed Donald Trump’s election was short lived, lasting just a few hours. Having kept to the risk-aversion script almost word-for-word (equity markets down, bond markets up, and the added twist of a fall in the dollar), financial markets quickly returned to normal. The most significant shift affected bond markets with 10-year Treasury Yield rising from 1.80% to over 2.20% in just a few days to reach levels last seen at the start of 2016.
Yields had started moving upwards after a low point in July, following the UK’s vote to leave the European Union. The US 10-year Treasury Yield then stood at 1.36%. Breaking down the 79 basis point rise in inflation-linked bond yields, 34 bps represent real interest rate rises and 45 bps represent inflation adjustment. Calculations based on inflation-linked swaps result in a higher portion of inflation adjustment.
The upturn in inflation started prior to the presidential election on the back of both rising wages and the halt in falling energy prices. It will be several months before Donald Trump’s policies are implemented, but his stimulus plans could buoy the economy and push an already low unemployment rate down further, potentially leading to even faster wage rises. Impacts on oil prices are not as clear-cut (domestic production versus greater isolationism) and will only be reflected in several years’ time meaning that, in the short-term, OPEC will have the greatest influence on oil. These factors suggest that inflation is likely to pursue its gradual acceleration in the short term, but that the presidential election has made higher medium-term inflation rates a possibility.
As for real interest rates, their persistently low levels reflect market expectations that the Fed will maintain its accommodating monetary policy stance in the long-term. However, both full employment and inflation argue for higher interest rates than the markets expect. In addition, if Donald Trump’s policies result in a significantly higher deficit, the Federal Reserve Board may be forced to accelerate the pace of rate rises. These factors combine to point firmly towards higher interest rates.
The opinion expressed above is dated November 14th, 2016 and is liable to change.
This document is not pre-contractual or contractual in nature. It is provided for information purposes. The analyses and descriptions contained in this document shall not be interpreted as being advice or recommendations on the part of Lazard Frères Gestion SAS. This document does not constitute an offer or invitation to purchase or sell, nor an encouragement to invest. This document is the intellectual property of Lazard Frères Gestion SAS.
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