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Categorized | Capital Markets

A pause in the Trumpflation trade: Bonds pick up, dollar stalls

Posted on November 17, 2016

European and US equity gauges are subdued as government bond yields dip from multi-month highs and the dollar stalls after hitting its strongest level since 2003.

Following a muted Asia-Pacific session — encapsulated by Japan’s Nikkei 225 closing unchanged — index futures suggest the S&P 500 will dip 2 points to 2,175 when the opening bell rings later in New York, leaving the Wall Street barometer just 1 per cent shy of a record high.

The pan-European Stoxx 600 index is down 0.2 per cent, as energy stocks struggle to make headway in the face of a Brent crude slipping 0.4 per cent to $46.43 a barrel. Miners are mostly firmer, welcoming higher copper prices and shrugging off news that iron ore prices in China recorded a third straight day of sharp declines.

However, it’s the dollar that remains a focal point for investors, its recent move to a 13-year high a symbol of the “Trumpflation trade” that has been shaping markets since the Republican candidate secured a shock presidential election win just over a week ago.

Investors have bought the buck and sold government bonds in expectation that Mr Trump’s policies of a huge infrastructure spending programme, along with tax cuts, will boost the US economy, stoke inflation, and cause the Federal Reserve to raise interest rates at a faster pace than previously thought.

The dollar index is 0.2 per cent weaker at 100.22, but closed on Wednesday at its highest level since April 2003, as futures markets see a 94 per cent chance that the Fed will increase borrowing costs by 25 basis points at its December meeting.

“The recent rally in the dollar may only be the beginning of the resumption of a broader uptrend over the next year,” said analysts at Citi. “Big levels are now in focus on the dollar index and a weekly close above the 100.50 area would signal a bullish break out of the multi-month consolidation”.

But some traders are wary that the greenback may be due a pullback given its latest surge. The dollar index’s 14-day relative strength index, a closely watched momentum measure, is 73.9, above the 70 level that marks a supposedly “overbought” trend.

Another aspect of the “Trumpflation trade” was a big sell-off in the longer-maturity portion of the fixed income market — a part of the bond sector most sensitive to inflation expectations.

The Bank of Japan has balked at the pick-up in bond yields, which rubs up against its policy of seeking to keep its 10-year yields at an upper limit of zero percent. Today, it showed its willingness to follow through on policies to keep that ceiling in place, offering to buy unlimited amounts of five- and two-year bonds.

The 10-year US Treasury yield, which moves inversely to the bond price, and which this week hit an 11-month high of 2.30 per cent having bounced from 1.80 per cent at the start of the month, is easing 3 basis points to 2.20 per cent.

A paring of the “Trumpflation trade” can also be seen in German Bund yields, which are off 2bp to 0.28 per cent, having brushed 0.40 per cent on Monday, the highest since January

Dollar strength continues to pile pressure on many Asian currencies, notably the Malaysian ringgit, down 1 per cent, and the South Korean won, down 0.8 per cent.

And it has also created a notable milestone for China’s renminbi, as the country’s central bank fixed the midpoint around which the currency is allowed to trade weaker for a record-equalling 10th session in a row to Rmb6.8692 per dollar.

China’s Shanghai Composite rose 0.1 per cent but Hong Kong’s Hang Seng dipped 0.3 per cent.