Don't count on US bonds entering a new long-term, secular bear market

FINANCIAL markets are still grappling with the implications of the US election. US treasury yields and stock prices have soared, defying the consensus view that there would be a flight to safety in the event of a Trump victory.

The narrative behind this massive shift in market sentiment looks compelling: the expectation of a substantial fiscal stimulus under a Trump administration. Big tax cuts and extra spending could push up growth and inflation in an economy already running close to full employment. Rising inflation could be reinforced by protectionist trade measures. Such developments should entice the Federal Reserve to keep gradually hiking interest rates.

While the details of tax cuts and additional government spending have not been unveiled, their overall size could be significant, not unlike in the Reagan era. If the fiscal deficit widens by 1.5 to 2 percentage points and the Republicans decide to lift the debt ceiling in March next year, this will have a significant impact on nominal growth in the US economy in upcoming quarters. Interest rates of 3 per cent for 10-year US treasuries would then be well within reach; temporarily they could even go higher. But, despite what some market watchers suggest now, this does not mean that bonds have entered a new long-term, secular bear market, in which rates return to 5 or 6 per cent.