Mind the “Trump gap”

Ariel Bezalel, Head of Strategy, Fixed Income, explains his caution on the Trump administration’s ability to deliver fiscal reforms, and why he has increased the duration in his funds for the first time since cutting it last summer.

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Following the recent positive economic data (albeit around mostly soft indicators such as consumer confidence surveys) and the continuation of the Trump reflation trade, it might seem that the US is on a path of unstoppable growth. However, my team and I believe that it is important to remain conscious of too much hope being priced in to risk assets.

As expected, the Federal Reserve raised the Fed funds rate by 0.25% to a range of 0.75-1% on 15 March. But the Fed’s statement struck a more dovish tone than anticipated by the markets, reducing the number of further expected rate hikes this year from three to two. In our view, this may be due to uncertainty around President Trump’s plan of action.

We remain cautious on what I am calling the "Trump gap" – that is, the scope for disappointment between now and when Trump delivers his policies. Firstly, we think it is highly unlikely that his trillion dollar infrastructure spending plan will successfully pass through Congress without being watered down. There are also indications that his tax reforms will be pushed back to next year.

In addition, we have noticed that lending standards at banks in the US appear to be tightening, leading to slower loan growth, which represents another potential risk for growth prospects.

As a result, we believe that US treasuries are showing signs of value once again.

With the US 10-year treasury yield reaching 2.5% in February, up from a low of 1.3% in July last year, and the 30-year yield at around 3%, we believe that valuations are already pricing in considerable macro improvements and do not take into account the possibility of the Trump administration failing to deliver on reforms.

Globally, political uncertainty is at unprecedented levels and we believe that this is a year where a tactical approach to bond investing will be crucial. Our approach has always been to be dynamic and flexible, adapting as the facts change. In light of this, we recently extended the duration of our portfolios from just over one year to approximately 3.2 years. We achieved this by increasing the funds’ 10-year and 30-year US treasury exposure and extending the duration of our Australian government bond position.

In this way, we are still keeping overall duration relatively low, while still taking into account the potential scope of disappointment in the US.

Ariel Bezalel April 2017

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