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The growing prospect of Donald Trump winning the US presidential election in November has helped revive a popular hedge fund bet on Treasury yields, in an echo of the so-called “Trump trade” that rocked global markets after his 2016 victory.
Investors have been putting on positions in anticipation that the former president’s tax-cutting and pro-trade tariff agenda could eventually lead to higher inflation and a greater supply of longer-dated government bonds.
A major catalyst for the trade has been President Joe Biden’s disastrous performance in the televised debate with Trump on June 27, which has increased expectations of a Trump victory and led managers to increase bets that longer-dated debt will perform worse than short maturity bonds.
Unlike in 2016, however, a key part of the trade has also been the belief that the US Federal Reserve will soon start to reduce interest rates as inflation heads towards target, which would weigh on short-term yields.
Since the debate the bet — known in industry jargon as a “steepener” because of the expected move in the yield curve — has paid off, with the two-year yield falling by roughly double the drop in the 10-year. Prices move inversely to yields.
“After the Biden-Trump debate, active managers ramped up their bets on a steepening of the US yield curve,” said Mario Unali, who manages a portfolio investing in hedge funds at Kairos Partners. “This is now hedge funds’ most popular position.”
He added that the effect on markets of a Trump win would depend on the size of the potential majority for the Republican party in Congress, which would affect the new president’s ability to pass legislation.
“Should the new administration implement tax cuts on top of tariffs and stricter immigration rules, a steepening of the US yield curve would be very likely. Long-dated bonds are still a dangerous place to be right now,” he said.
In a high-tariff scenario, the trade is expected to pay off because of the 10-year yield’s sensitivity to inflation expectations. Tax cuts could also be inflationary, and could mean an even bigger fiscal deficit, requiring more long-dated bonds to be issued, which could drive yields higher.
Meanwhile, the two-year yield has dropped from as high as 5 per cent in late May to 4.46 per cent as the market has again turned more optimistic on the prospect of US rate cuts. Investors are now pricing in two or three quarter point cuts this year after a series of data reports showing that inflation in the US is slowing and unemployment is ticking up.
“The fundamental economic data is the big story, Trump is the icing on the cake,” said one US-based macro hedge fund executive who has this trade on.
Longer-dated debt sold off sharply relative to short-dated bonds in the immediate aftermath of Trump’s shock November 2016 election victory, although the move had eventually unwound by midway through 2017.
The US-based macro executive added that the attempted assassination of the Republican candidate on Saturday meant that a Trump presidency was more likely, adding to existing market enthusiasm for the steepener trade.
“People are getting more excited about Trump and a red sweep and those odds have clearly gone up, with the assassination attempt jump-starting that a bit further,” said a US macro hedge fund executive.
“The steepener makes sense to us. We have been in and out of it continually for a number of months and believe in it for a number of reasons . . . The curve looks unnaturally flat to us on the doorstep of a rate cutting cycle.”
However, until recently, steepener trades have been a costly bet so far this year, with longer-dated Treasuries outperforming short-dated from mid-January until late June as investors reined in their bets on rate cuts this year.
Tom Roderick, portfolio manager at hedge fund firm Trium Capital, said he could see the logic of the trade, but thought there was still too much uncertainty over whether the Fed would cut rates.
“Unless jobs or inflation data moves in a decisively negative direction, I think the Fed will have a tough time going through with rate cuts,” he said.
Investors also cautioned that there was still a long time to go before the election and that many traders may be waiting until the outcome is known to place large positions.
Additional reporting by Laurence Fletcher, Harriet Clarfelt, Mary McDougall and Ray Douglas in London
