Donald Trump's surprise victory in Tuesday's Presidential elections has ignited an even more shocking reaction in global bond markets that could slow the pace of stock gains as investors nurse billions in losses and central banks slow the pace of money printing.
Government bond prices are falling around the world at the fastest pace in more than year Thursday, lifting benchmark yields to multi-month highs as investors prepare for what could be the biggest peacetime spending spree in U.S. history. President-Elect Trump's plans to reform corporate and personal taxes could, if pushed through a now-friendly Congress controlled by Republican lawmakers, provide a $9.5 trillion stimulus to the world's biggest economy over the next 10 years.
The unprecedented fiscal expansion - about half of U.S. GDP - could also add more than $5.3 trillion to the country's already staggering $14 trillion in outstanding debt, according to the Committee for a Responsible Federal Budget.
Bond investors reacted in typically nervous fashion, lifting yields on 10-year U.S. Treasury past 2.12%, the highest since January. Benchmark 10-year German bunds, long held down by the European Central Bank's massive €1.4 trillion ($1.5 trillion) quantitative easing programme, have gone from trading at a near-zero at the peak of the election chaos early Wednesday to 0.32% Thursday, the highest since March.
Bloomberg calculated the single-day loss for global bond investors at $337 billion, a trend that is likely to continue as investors place increasing bets on a U.S. Federal Reserve rate hike next month and re-calibrate assumptions for inflation and growth on the back of Trump's 'shovel-ready' infrastructure boom.
Definitive assumptions are nearly impossible at this stage, given the vague - and un-costed - nature of Trump's promises and his lack of any experience working in the kind of consensus-building framework that is politics in Washington. But if investors are now looking at the kind of long-term, inflationary change to the global macro-economic backdrop, it's no exaggeration to say that we could also be staring into the face of a seismic market event: the bursting of the bond market bubble.
Near-zero interest rate policies have defined central banking since the worst of the global financial crisis in 2008 and active (and perhaps growing) quantitative easing programmes are still in place in the U.K., Europe and Japan. But inflation is expected to triple in Britain next year as the post-Brexit pound weakens, accelerating domestic price rises and testing the Bank of England's tolerance if inflation exceeds its 2% target. The same could eventually be true for the ECB, which still applies negative rates to its deposit facility and has fought in vain to ignite consumer prices amid tepid economic growth in the crisis-prone euro zone.
If the current market dynamic continues, and rising yields boost the dollar, 'Trumpenomics' lifts commodity prices and non-dollar currencies decline, central banks - who have been dreaming of such a collection of events of the past five years - will quickly react.
U.S. yields will probably move fastest, but not to the point of significant concern, however, given that Britain's economy could slow significantly post-Brexit, the Bank of Japan has a yield ceiling on 10-year bonds and the ECB is locked in to low refinancing rates until at least 2019. That probably means global fixed income investors will pile into the newly-printed Treasuries, with the bullish price action acting as a circuit-breaker of sorts to rampant rate increases (prices and yields, or course, move inversely).
However, such a shift won't come without cost. Many fixed income portfolios, enticed by central bank bidding, added to positions as global rates declined, leaving them uncomfortably exposed to rising yields. Single-day losses of $337 billion aren't likely to be the norm, but there will be losses nonetheless, and covering those losses might require the sale of the world's most liquid assets: U.S. equities.
It's a long-form play, to be sure, but it's also a reminder of the interconnectivity of global financial markets and the need for investors to keep a keen eye on other asset classes as they make their near-term decisions on allocation.