Trump And U.S. Treasury Yields

Given recent improvements in global growth and breakouts in global bourses post-Brexit, the low bond yields represent a conundrum. Could Trump really be an answer to the puzzle?

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The 10-year nominal rate is inversely correlated with the probability of Donald Trump winning the U.S. election. So why buy Treasurys as a hedge against a Trump presidency? Generally speaking, Trump is a reason to own safe-haven assets for two reasons:

Trade: Trump could start a trade war with China in 2017. The consequences of a mercantilist America would be profound, potenitally throwing the world economy into a 1930s-like “beggar-thy-neighbor” spiral at a time when global trade is already weak.

Geopolitics: Trump is right when he says that the world is a mess because America is weak. The rest of the world has become a lot more powerful in the last two decades of relative peace and prosperity. The end result is global multipolarity, where numerous countries can pursue their interests independent of one another. We know from political science theory, formal modeling, empirical analysis, as well as the last five years of conflagrations that such a distribution of power is the most likely to create the sort of “messy world” that Trump claims he will “fix”.

Our U.S. bond strategists are not too surprised by the above relationship. They have pointed out that economic factors alone cannot explain the most recent downleg in bond yields. Rising “policy uncertainty”, which includes U.S. politics, has also been depressing bond yields.

Is China Transitioning Into A Free Market Economy?

The financial community still tends to assume that China will eventually become a Western-style developed market economy. Our geopolitical strategists do not think this is realistic.

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There is no doubt that the service sector continues to improve at the expense of the long-dominant manufacturing and resource sectors. However, it is very unlikely that China will abandon investment-led growth anytime soon. Chinese people are admirable savers, which necessitates a high level of investment. Exporters are unable, and consumers unready, to pick up the slack in GDP growth if investment is cut. Poverty and regional disparities remain challenges that only large-scale investment can address. Further, the investment model may be inescapable until China’s leaders embrace political decentralization and rule of law, and accept the socio-political realities of “consumer sovereignty.”

As for state involvement, the government currently supports SOEs as the backbone of key sectors and prevents liquidation even of non-strategic and failing quasi-state companies. As long as this continues, truly private business will operate at a disadvantage.

As for foreign access, China is getting more, not less, protectionist as it moves up the production value chain and develops a consumer economy. There is no reason to think the Xi administration will reverse course on this front.

Bottom Line: Weak but stable growth, financial instability, and simmering but not boiling social discontent do not encourage aggressive reform initiatives.