Why Donald Trump won't beat the market

President Donald Trump’s first week in office has been busy. He has approved hundreds of executive actions, threatened Denmark and released insurrectionists from prison. He has also helped broker a ceasefire in the Middle East, banned offshore windfarm construction and waded into the financial markets, saying he will “demand that interest rates drop immediately”.

Many of his policies rely on the threat of force. In the short term, this strategy can generate some success. The problem for Trump is the market looks at the long term. He can "demand” lower interest rates, but the market cannot be threatened. It’s just a mechanism that reveals a collective preference.

This short-term style of presidency is now being reflected by the divergent bond market. Since September, the Federal Reserve has cut interest rates by 100 basis points, yet the US 10-year treasury yield has risen. A few weeks ago, Apollo’s chief economist Torsten Slok called this “highly unusual”. 

The Squeeze has hypothesised this was a combination of the US’s higher nominal growth expectations and the market’s scepticism about US government debt affordability. A recent article from the Center for Economic Policy Research (CEPR) has added an extra layer of detail to this picture. It points to the fact that the rise in the 10-year yield since September has coincided with “a substantial reduction in dollar reserve assets held by foreign official institutions”.

In other words, foreign central banks have started selling down their US treasury holdings. The article’s author, Johns Hopkins economics professor Alessandro Rebucci, explained to The Squeeze that usually this wouldn’t impact rates that much. However, private buyers, such as retail investors and hedge funds, aren’t picking up the slack, leaving treasuries sitting on the balance sheets of market makers.

The other insight from CEPR is that this sell-off has coincided with an increase in the price of gold, which is up 36 per cent in the past year. Importantly, most of the appreciation has happened during non-US trading hours, “which may indicate robust foreign demand for gold from countries such as China”. This might also explain the rising price of Bitcoin, with Rebucci saying he “doesn’t know for certain but it is plausible” DIY investors are increasingly looking to Bitcoin as an alternative asset.

The unanswered question is why foreign officials are deciding to sell US treasuries. For years, the US has benefitted from lower interest rates because of the strong demand from the rest of the world for treasuries. But now, they look increasingly less attractive.

One theory is that the threat of US economic sanctions is rising. In the past few years, the US has been happy to use sanctions against enemies. In 2018, it froze the assets of Iran and then did the same for Russia in 2022. But now, Trump is threatening anyone and everyone. On Sunday, he said he would impose sanctions on Colombia in response to the South American country saying it would not accept deportation flights until the US provides a process to treat Colombian migrants with “dignity and respect”.

Measuring the exact impact of the sanction fears on investor decisions is impossible. As with any price movement, it is always a combination of multiple factors. But it seems intuitive that a country with a president who has shown little interest in reducing debt, and is now showing little prudence with his economic threats, would have fewer willing buyers for its debt.

If US borrowing rates stay high, it will start to impact average Americans. Having fallen in the first half of 2024, the 30-year mortgage rate is now almost back up to 7 per cent, and housebuilders DR Horton and Pultegroup’s share prices are down 19 per cent and 11 per cent respectively. 

Some voters believe that the right politician can fix all their problems, but there is a limit to everyone’s power. Trump might be able to coerce Colombia, but it is another matter with the world’s largest and most liquid market for government securities. And as Rebucci reminded The Squeeze: "When politicians try to take the market by the horns and tell it what to do, that is when they get in trouble."