The City wakes this morning to a grim reality: the supposed ‘Trump Bump’ is unravelling faster than a poorly hedged derivative. Inflation figures out of Washington have confounded expectations, with consumer prices surging 5.4% year on year, far above the Federal Reserve’s comfort zone.
The bond market, that great barometer of fiscal sanity, is screaming bloody murder. The yield on the 10-year US Treasury has blasted through 4.7%, a level not seen since the dot-com era.
In London, gilt yields are catching a sympathetic cold, pushing the yield on the 10-year gilt above 4.3% for the first time in two decades. This is not just a tremor; it is a seismic shift in the landscape of global capital.
The recent tax cuts and deregulation, hailed as the elixir of growth, have instead brewed a toxic cocktail of demand-pull inflation and supply-side bottlenecks. The market is now pricing in a higher probability of a rate hike than a cut at the next FOMC meeting. Capital is fleeing risk assets, and the dollar, despite its safe-haven status, is showing cracks.
Sterling is feeling the heat, with the pound dropping below $1.26. The Bank of England, already in a tight spot with its own inflation dilemma, now faces the spectre of imported inflation via a weaker dollar.
The fiscal discipline that markets had naively hoped for is nowhere to be seen. Trump’s gamble that tax cuts would pay for themselves has been exposed as the hokum that any sensible economist knew it to be. The deficit is ballooning, and the national debt is on course to exceed 120% of GDP.
The bond vigilantes are sharpening their knives. If the US Federal Reserve does not act decisively, we risk a taper tantrum of 2013 proportions, but with far greater geopolitical risk. The correlation between US inflation and global capital flows is a brutal one: hot money heads for the exits, and emerging markets will be first to feel the pain.
The UK, with its own ‘Corbyn premium’ fading and Brexit uncertainty lingering, cannot afford to be complacent. Chancellor Hammond must be sweating bullets; the headroom for fiscal stimulus has evaporated. The BoE may have to raise rates pre-emptively to defend the pound, which would choke off any nascent recovery.
The bottom line is this: investors who believed the narrative of ‘balanced growth’ have been sold a swaption that is now deep in the money. The time to hedge is now.
