Trump Presidency Ignites Bond Yields on Inflation Expectations
The “Make America Great Again” ethos has set the greenback on fire. Donald Trump's re-election has the US dollar surging 2%, extending its rally since early October to a total gain of 5%.
This resurgence is despite the anticipated 25 basis points (“bps”) rate cut at the November FOMC meeting. Dollar rally is driven by expectations of potential policy changes by the Trump Presidency.
HIGHER INFLATION EXPECTATIONS UNDER TRUMP 2.0
Trump’s election victory, combined with the Republican sweep of the Senate and the House of Representatives, gives the party the leverage to enact swift and substantial legislative changes.
His policies, such as corporate-friendly tax cuts & light-touch regulations, are expected to amplify corporate growth. These policies, combined with import tariff imposition, are expected to drive inflation higher. Rising inflation will curtail the pace of rate cuts by the Fed.
Rate cut expectations have eased since election. On November 6 (election day), projections pointed to rates reaching 350-375 bps on election day (6/Nov) per CME FedWatch tool. Now, they are expected to reach 375-400 bps.
Trump has previously pushed the Fed towards accommodative rate environment. Fed Chair Powell re-iterated that the Fed remains independent and data driven.
Trump's proposed tariff policy will further strengthen the dollar. In August 2023, Trump announced plans for a universal 10% tariff on all U.S. imports, reiterating that tariffs on Chinese goods could be even higher, potentially reaching 60%-100%.
Such tariffs are expected to drive inflation higher. It will raise consumer prices and provoke retaliatory actions from trading partners, worsening inflation. Trump aims for these tariffs to revitalize American manufacturing and reduce reliance on imports which collectively support a stronger dollar.
STRONGER DOLLAR TRIGGER BOND YIELD SURGE
The resurgent dollar has contributed to the sharp rally in bond yields. The yield rally since October has resulted in the 10Y yield rising by 60 bps. Yields initially surged after the election result but partially reversed the following day after the FOMC meeting.
It currently stands 5 bps higher than the pre-election level.
Unlike the yield, the yield spread has remained flat since October. Higher for longer rates act to push this spread lower.
The Federal Reserve reaffirmed (at its Nov meeting) its dovish tone as Powell pointed to signs of an easing job market and slowing inflation. However, its impact on curbing bond yields was limited.
According to a JP Morgan report, while Fed Chair Powell has consistently conveyed a dovish tone over the years, the Fed's actual decisions have often skewed hawkish.
Although Powell’s dovish statements have initially brought bond yields down, the hawkish policy actions and Fed’s wait and watch approach that followed have typically led to renewed yield increases. This explains why yields continue to rise despite Powell’s dovish remarks at the November meeting.
HYPOTHETICAL TRADE SETUP
Treasury bond yields have been on the rise since October and Trump’s win has supercharged the rally. Investors are expecting higher inflation due to Republican policies which favour corporate growth.
Import tariff, if enacted, would have an even larger impact on the dollar and bond yields. However, actual policy plans remain uncertain for now.
While yields initially surged after the elections, they partially reversed shortly after as the Fed signalled a dovish stance. Despite this, the 10Y-2Y yield spread has remained unchanged.
Resurgent inflation will lead to the Fed slowing the pace of rate cuts. The recent reversal in yield spreads may be unsustainable given the expectation for slower rate cuts. When Trump administration announces policy plans, yields could surge even more strongly.
This week’s CPI release is anticipated to influence bond market movements. Analysts expect October’s YoY inflation to remain steady at 2.4%. If inflation holds at this level, it may have minimal impact, aligning with the Fed’s "watch and wait" strategy. However, a sharper-than-expected drop in inflation could reinforce expectations of quicker Fed rate cuts.
With the impact of inflation most apparent on the longer-tenor yields, investors can focus the position on the 10Y-2Y spread.
CME Yield Futures are quoted directly in yield with a 1 basis-point change representing USD 10 in one lot of Yield Future contract. This simplifies spread calculations with a 1 bps change in spread representing profit & loss of USD 10.
The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively. However, with CME Group’s 50% margin offset for the spread, the required margin drops to USD 325 as of 12/Nov, making this trade even more capital efficient.
A hypothetical long position on the CME 10Y yield futures and a short position on the 2Y yield futures offers a reward to risk ratio of 1.3x is described below.
Entry: 6.2 basis points
Target: -11.5 basis points
Stop Loss: 20 basis points
Profit at Target: USD 177 ((6.2 - (-11.5)) x 10)
Loss at Stop: USD 138 ((6.2 - 20) x 10)
Reward to Risk: 1.3x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
This resurgence is despite the anticipated 25 basis points (“bps”) rate cut at the November FOMC meeting. Dollar rally is driven by expectations of potential policy changes by the Trump Presidency.
HIGHER INFLATION EXPECTATIONS UNDER TRUMP 2.0
Trump’s election victory, combined with the Republican sweep of the Senate and the House of Representatives, gives the party the leverage to enact swift and substantial legislative changes.
His policies, such as corporate-friendly tax cuts & light-touch regulations, are expected to amplify corporate growth. These policies, combined with import tariff imposition, are expected to drive inflation higher. Rising inflation will curtail the pace of rate cuts by the Fed.
Rate cut expectations have eased since election. On November 6 (election day), projections pointed to rates reaching 350-375 bps on election day (6/Nov) per CME FedWatch tool. Now, they are expected to reach 375-400 bps.
Trump has previously pushed the Fed towards accommodative rate environment. Fed Chair Powell re-iterated that the Fed remains independent and data driven.
Source: CME FedWatch
Trump's proposed tariff policy will further strengthen the dollar. In August 2023, Trump announced plans for a universal 10% tariff on all U.S. imports, reiterating that tariffs on Chinese goods could be even higher, potentially reaching 60%-100%.
Such tariffs are expected to drive inflation higher. It will raise consumer prices and provoke retaliatory actions from trading partners, worsening inflation. Trump aims for these tariffs to revitalize American manufacturing and reduce reliance on imports which collectively support a stronger dollar.
STRONGER DOLLAR TRIGGER BOND YIELD SURGE
The resurgent dollar has contributed to the sharp rally in bond yields. The yield rally since October has resulted in the 10Y yield rising by 60 bps. Yields initially surged after the election result but partially reversed the following day after the FOMC meeting.
It currently stands 5 bps higher than the pre-election level.
Unlike the yield, the yield spread has remained flat since October. Higher for longer rates act to push this spread lower.
The Federal Reserve reaffirmed (at its Nov meeting) its dovish tone as Powell pointed to signs of an easing job market and slowing inflation. However, its impact on curbing bond yields was limited.
According to a JP Morgan report, while Fed Chair Powell has consistently conveyed a dovish tone over the years, the Fed's actual decisions have often skewed hawkish.
Although Powell’s dovish statements have initially brought bond yields down, the hawkish policy actions and Fed’s wait and watch approach that followed have typically led to renewed yield increases. This explains why yields continue to rise despite Powell’s dovish remarks at the November meeting.
HYPOTHETICAL TRADE SETUP
Treasury bond yields have been on the rise since October and Trump’s win has supercharged the rally. Investors are expecting higher inflation due to Republican policies which favour corporate growth.
Import tariff, if enacted, would have an even larger impact on the dollar and bond yields. However, actual policy plans remain uncertain for now.
While yields initially surged after the elections, they partially reversed shortly after as the Fed signalled a dovish stance. Despite this, the 10Y-2Y yield spread has remained unchanged.
Resurgent inflation will lead to the Fed slowing the pace of rate cuts. The recent reversal in yield spreads may be unsustainable given the expectation for slower rate cuts. When Trump administration announces policy plans, yields could surge even more strongly.
This week’s CPI release is anticipated to influence bond market movements. Analysts expect October’s YoY inflation to remain steady at 2.4%. If inflation holds at this level, it may have minimal impact, aligning with the Fed’s "watch and wait" strategy. However, a sharper-than-expected drop in inflation could reinforce expectations of quicker Fed rate cuts.
With the impact of inflation most apparent on the longer-tenor yields, investors can focus the position on the 10Y-2Y spread.
CME Yield Futures are quoted directly in yield with a 1 basis-point change representing USD 10 in one lot of Yield Future contract. This simplifies spread calculations with a 1 bps change in spread representing profit & loss of USD 10.
The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively. However, with CME Group’s 50% margin offset for the spread, the required margin drops to USD 325 as of 12/Nov, making this trade even more capital efficient.
A hypothetical long position on the CME 10Y yield futures and a short position on the 2Y yield futures offers a reward to risk ratio of 1.3x is described below.
Entry: 6.2 basis points
Target: -11.5 basis points
Stop Loss: 20 basis points
Profit at Target: USD 177 ((6.2 - (-11.5)) x 10)
Loss at Stop: USD 138 ((6.2 - 20) x 10)
Reward to Risk: 1.3x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
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