In recent weeks, you may have seen mention of the "Trump Bet", which first emerged in 2016 in the run-up to the last US Presidential election. It revolves around market expectations in the event that former President Donald Trump was to be re-elected. Since Joe Biden's withdrawal, appetite for the so-called "Trump Bet" has reduced, but it is still an interesting concept. So, how does it work?

 

Fiscal policy and government spending

 

Central to the “Trump Bet” are the fiscal policies and government spending plans associated with the former president. If he were re-elected, experts believe we would see tax cuts or increased government spending on infrastructure and defence. Even though these moves would encourage economic growth in the long term, they are likely to lead to an increase in the government’s budget deficit, which would need to be balanced via increased government borrowing.

 

The expectation is that this would lead to higher interest rates to attract investors, especially if many believed these fiscal policies were unsustainable in the longer term.

 

The impact on inflation

 

Looking back on previous economic cycles, expansionary fiscal policies have historically reignited inflation, especially when economies are near or at full employment. This, in turn, would prompt the Federal Reserve to increase base rates and the cost of finance—not the ideal scenario for a controlled period of economic growth!

 

Trade policies and economic uncertainty

 

If there is one thing we can be fairly sure of, it is the re-emergence of numerous trade wars in the event that Donald Trump is re-elected. History shows that tariffs and trade wars can disrupt global supply chains, increasing the general cost of goods and services for businesses. This, in turn, can increase inflationary pressures, prompting a likely increase in US (and global) interest rates.

 

Any uncertainty regarding global trading relations tends to filter into financial markets, making them more volatile and increasing the risk premium—part of the interest rate landscape. Then, yes, you’ve guessed it; any degree of uncertainty will increase the risk to investors who will demand higher interest rates as compensation.

 

Monetary policy influence

 

Even though, just like the Bank of England, the Federal Reserve is independent of the US government, government fiscal policies can and do influence decisions. In the event of a Trump victory, this could force the Fed to take pre-emptive action, increasing interest rates to combat the potential threat of inflation and prevent the economy from overheating.

 

Conversely, in a situation that suggests investors have all angles covered, if markets believe that an incoming President Trump was likely to pressure the Fed into maintaining low interest rates, this would call into question future decisions. Again, as uncertainty is the nemesis of financial markets, any confusion or uncertainty would introduce a risk premium and push interest rates higher. Is there any escape?

 

Summary

 

The “Trump Bet” involves investors shortening long-term bonds amid expectations that interest rates will rise and bond prices will fall. Many would also be attracted by inflation-protected securities or financial stocks, which tend to benefit from higher rates. On the flip side, those who don't expect Trump to win would likely buy into bonds, utilities, and other rate-sensitive sectors, expecting interest rates not to rise.

 

In summary, the “Trump Bet” is dependent on higher government spending, upwards inflationary pressure, and an increase in the budget deficit. These would all contribute to higher interest rates and provide an opportunity for investors to short long-term bonds as a means of benefiting from or hedging against rising rates. So, where is your money?

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