The Case for Disinflation During Trump's Presidency

When inflation risk is high, bond investors demand a higher yield to compensate for the decreased purchasing power of a bond's future cash flow.

Hence, inflation is bad for bond holders because higher yields mean lower bond prices.

Since Donald Trump was elected, bond yields have soared. For example, in the past two weeks, 5-year U.S. Treasury yields saw their biggest two-week jump ever.

So, some debt market observers say that Trump's election victory has stirred inflation fears.

But a Nov. 26 Marketwatch article titled "Why Trump may be deflationary after all" reminds readers that yields started rising before Trump was elected and goes on to make the case for disinflation:

Bond yields were starting to creep up even when everyone thought Clinton would win, so giving Mr. Trump credit for the bond breakdown isn't fully valid. However, there is no doubt that his surprise win did add significant fuel to the bond selloff fire on the belief that his policies will be inflationary. But perspective does matter here — yields are still incredibly low relative to history.

Inflation expectations have been creeping up accordingly. The question now is whether those expectations will ultimately be right, as the Fed likely will more aggressively hike rates to temper fiscal stimulus. If the shock in bonds has overshot, the key to determining when to leg back in will be reflation reality, as opposed to inflation hope.

When looking at the iShares TIPS Bond ETF TIP, +0.15% relative to the iShares 7-10 Year Treasury Bond ETF IEF, +0.46% the gap up in inflation expectations may not actually hold. Yes, the uptrend remains in place, but I wouldn't be surprised at all to see disinflationary fears return on a Trump overshoot.

While debt arguably can be short-term inflationary, it tends to be more disinflationary over the long term the larger that debt load becomes. One must then question whether Trump will be inflationary given that the starting point for fiscal debt is as high as it currently is. The fly in the ointment for the belief that Trump will be inflationary is the strength in the U.S. dollar, which has surged in an incredible way. Inflation pressure should, in theory, result in a depreciating currency, not a surging one.

You can read the entire article by following the link below: