Real yields on 10-year government bonds have dropped to a recent low of 0.38% after rising to 0.74% during their mid-December post-election peak. According to the Wall Street Journal, this could be a sign that bond investors are growing increasingly concerned that President-Elect Trump's economic policies, including import tariffs, could hamper his growth plans. Inflation-adjusted yields, which measure the actual purchasing power investors obtain from investing in government bonds, tend to rise on expectations of a strengthening economy, however, they are now beginning to fall - signaling the opposite. (For more, see: Not Buying the Trump Rally? Here Are BAML's Contrarian Plays.)
"Real" Yields Fall From Post-Election Highs
Inflation-adjusted bonds, like Treasury Inflation Protected Secutities (or, TIPS), have "real" yields which subtract the effects of inflation from the interest rate it pays. The Wall Street Journal cites the fact that such real yields on U.S. government bonds have fallen sharply over the past month, "the latest sign of moderating market expectations for the Trump administration’s economic plan." (See also: How Trumponomics Might Boost the Stock Market.)
Indeed, immediately after Trump's surprise victory, equity markets rallied on optimism that pro-growth policies will spur economic growth and increase corporate profits over the next few years. At the same time, bond markets around the world sold off as interest rates rose, along with the dollar, in anticipation of economic growth, which could lead to inflation and tightening of monetary policy.
But now, it appears that this euphoric rally may be running out of steam. After a number of failed attempts to reach the 20,000 level, the Dow Jones Industrial Average has remained relatively flat over the past month. At the same time, the strength of the dollar has also moderated, and now bonds are casting yet another omen.
Inflation Expectations Indicate Trump Can't Deliver
Markets are questioning Trump's ability to actually implement and enforce measures such as trade tariffs, for fear of starting a trade war with neighbors such as Mexico, Latin America's second-largest economy, and China, the world's second-largest economy. Conservative Republicans, who have traditionally favored unencumbered free trade, may oppose protectionist measures. At the same time, Trump's promise to bring jobs back to the U.S. may be hindered by the realities of global capital markets and the effect of new technologies on job losses. Taken together, inflation expectations are ticking lower as investors believe that the new president will be unable to deliver on all of his campaign promises. (For more, see: Profit, Growth, Inflation Expectations Hit Multi-Year Highs.)
The Bottom Line
The Trump honeymoon may be over in terms of lofty expectations for an economic boom in the U.S. over the next months and years. Real bond yields have fallen, signaling that investors are no longer as optimistic about growth forecasts as it appears increasingly likely that Trump will have a difficult time getting some policies through congress, such as tariffs, which could spark an international trade war if passed.