Matt Levine of Bloomberg, my all-time favorite financial columnist, writes …
“In the week after Donald Trump‘s U.S. election victory, investors pulled more cash out of U.S. fixed-income funds than at any time over the last three years, in one early sign that the recent bond selloff may have legs. Big selloffs in bond markets often go hand in hand with investors taking money out of mutual funds. This can create a vicious cycle, whereby selling begets more selling.“
Let that sentence sink in for a bit. If it doesn‘t scare the daylights out of you, you are not reading it closely enough.
What Mr. Levine is trying to say is that the bond rout of the past few weeks may be just a preview of things to come. The fact is U.S. bonds are now going to sport a permanent risk premium. And that means they are unlikely to offer the kind of long-term return fixed–income investors have been so used to. It will take years to wring the complacency out of the market. And in the meantime, it will grind millions of bond buyers into dust as they naively try to “lock in” every fresh new top in yields.
Now let‘s think about it this for a second. If yields are headed higher, why would investors want to own stocks? If they could lock in guaranteed returns that were rising, why bother with the uncertainty of stocks? Sure, the environment looks benign now. But if yields on the 10–year go to 3%, stocks will lose a lot of their luster and the selloff will be more vicious and sudden than anyone imagines.
The bond rout of the past few weeks may be
just preview of things to come.
Which brings me to my favorite market. Currencies. In the currency market, we love volatility. And with President-elect Trump essentially a one-man volatility machine, forex is sure to offer opportunities galore. Mr. Trump has already set his sights on the Federal Reserve, trying to pressure Ms. Yellen into raising rates faster. (Why he would do such a thing frankly befuddles me. For a president to ask the Fed for higher rates is like a basketball player asking a referee for a foul. Higher rates could only make Mr. Trump‘s plans for massive infrastructure spend more expensive.)
In any case, the pressure has risen on the Fed to act sooner rather than later. And this week, the market will get a preview of their thinking when the Federal Open Market Committee releases the minutes of their latest meeting, which took place just before the election. The conventional wisdom at the time was that Hillary Clinton would win and that the Fed would follow a “gradualist” approach to normalizing rates. That should make the reading of the notes in the wake of the Trump election even more interesting.
With Thanksgiving on the docket, the currency markets — like the rest of capital markets — are likely to slow down. But don‘t be fooled: Next week, with the U.S. employment report on the calendar, volatility in the currency market will return with a vengeance. And that should provide us with plenty of opportunities to take advantage of the price action. Let the volatility begin!