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The growing prospect of Donald Trump winning November’s US presidential election has helped revive the popular hedge fund’s bet on government bond yields, echoing the so-called “Trump trade” that rattled global markets after his 2016 victory.
Investors took positions on the expectation that the former president’s agenda of tax cuts and pro-trade tariffs could eventually lead to higher inflation and a greater supply of longer-maturity government bonds.
The main catalyst for the trade was President Joe Biden’s disastrous performance in a televised debate with Trump on June 27, which raised expectations of a Trump victory and led managers to increase bets that longer-dated debt will outperform short-dated bonds.
However, unlike in 2016, a key part of the trade is also the belief that the US Federal Reserve will start cutting interest rates soon as inflation moves towards the target, which would weigh on short-term yields.
Since the debate, the bet — known in industry jargon as a “sharpener” because of the expected movement in the yield curve — has paid off, with the two-year yield down roughly double the 10-year decline. Prices move inversely with revenues.
“After the debate between Biden and Trump, active managers increased their bets on the steepness of the US yield curve,” said Mario Unali, who manages the hedge fund portfolio at Kairos Partners. “This is now the most popular hedge fund position.
He added that the impact of a Trump victory on markets would depend on the size of the potential GOP majority in Congress, which would affect the new president’s ability to pass legislation.
“If the new administration were to implement tax cuts in addition to tariffs and stricter immigration rules, it would be very likely that the US yield curve would steepen. Long bonds are still a dangerous place to be right now,” he said.
In the high-tariff scenario, the trade is expected to pay off due to the sensitivity of the 10-year yield to inflation expectations. Tax cuts could also be inflationary and could mean an even bigger fiscal deficit, requiring the issuance of more long-term bonds, which could raise yields.
Meanwhile, the two-year yield fell to 4.46 percent from 5 percent at the end of May as the market again became more bullish on the prospect of a U.S. rate cut. After a series of data reports showing US inflation slowing and unemployment rising, investors are now pricing in two or three quarters this year.
“Economic fundamentals are the big story, Trump is the icing on the cake,” said one U.S.-based macro hedge fund manager in charge of the trade.
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Longer-term debt sold off sharply against short-term bonds in the immediate aftermath of Trump’s shock election victory in November 2016, although that move eventually faded in mid-2017.
The U.S.-based macro executive added that Saturday’s assassination attempt on the Republican nominee meant a Trump presidency was more likely, adding to the market’s existing enthusiasm for the trade with steeper prices.
“People are getting more and more excited about Trump and the red sweep, and those odds have clearly increased, the assassination attempt kicked it off a little further,” said an executive at a US macro hedge fund.
“The stink bug makes sense to us. We have been in and out of it continuously for several months and believe in it for many reasons. . . The curve looks unnaturally flat to us at the threshold of the rate-cutting cycle.”
But until recently, steeper deals have been a costly bet this year, with bonds with longer maturities from mid-January to late June outperforming short-dated ones as investors hedged their bets on a rate cut this year.
Tom Roderick, a portfolio manager at hedge fund firm Trium Capital, said he sees the logic behind the deal, but still thinks there is too much uncertainty about whether the Fed will cut rates.
“Unless the jobs data or inflation moves in a decidedly negative direction, I think the Fed is going to have a tough time cutting rates,” he said.
Investors also warned that the election is still a long way off and that many traders may wait until the result is known to place large positions.
Additional reporting by Laurence Fletcher, Harriet Clarfelt, Mary McDougall and Ray Douglas in London