US: Are markets at the brink of a paradigm shift after Trump? - TDS

Research Team at TDS, believes that the reaction in the US market after the election is consistent with a perceived shift from monetary accommodation to fiscal stimulus, delivered into a market where 5y5y TIPS breakevens were trading 50bps cheap to their model and prone to a correction.

Key Quotes

“With Republicans controlling all three chambers of government, the odds of a meaningful shift in policy have risen, but details remain scant. As a rough rule of thumb, we find every $250bn in government infrastructure spending would imply an additional 25bps of Fed tightening while every percentage point cut in the average income tax rate would imply 32bps of Fed tightening.  This creates a risk of at least four additional hikes from the Fed over the next two years beyond the three we currently expect, if Trump’s campaign plan were delivered.”

“Uncertainty is high but for now we believe that that the market will continue to give President-elect Trump the benefit of the doubt. The key question for the market is fiscal stimulus versus trade protectionism, with the former being positive for growth and risk assets while the latter is more of a stagflationary impulse. We think that the 10y can peak around 2.50-2.75% if the market comes to expect $500bn in additional deficits in 2017. With the Fed expected to hike in December and stay cautious about the pace of hiking, we believe that the curve has some more room to steepen (5s-30s to 150bp). We think 10y TIPS breakevens can rise to 2.25% and the 5s-30s swap spread curve can invert to –70bp.”