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US inflation higher if “the Donald” gets his way

The “global geo-political risk” inspired reversal of US Treasury Bond yields from above 2.50% to the current 2.25% provides a short—term golden opportunity for borrowers and investors alike to re-position themselves for the future. If you believe that the Syrian and North Korean tensions will escalate further from here into more severe outright conflict involving the US, China and Russian you will not follow the recommended strategy for borrowers to lengthen their portfolio duration and investors to shorten theirs from the current market window of opportunity. If you however believe that no-one has ever solved the conflict and tension inherent in Middle East and the Korean peninsula, thus the current geo-political risks in the markets will reduce in intensity, then the current “safe-haven” investors flows will not continue and soon reverse. Currently it is a standoff between geo-political worries sending long term interest rates lower and economic conditions and trends in the US that fully justify higher short-term and long-term interest rates. Pretty soon the financial and investment markets will realise that the underlying economics will win out, as everyone has far too much to lose if the current geo-political tensions escalate. The US economy continues to truck on, producing the inevitable inflation increases as resources tighten up. Energy prices are no longer falling and wages rates are increasing. The Chinese Government and their sovereign wealth funds who have their funds invested in US Treasury Bonds will be eyeing the opportunity of this safe haven induced rally down in yields to offload bonds at a better price (lower yields) than what they would have expected a few months back.

One interesting aspect on the outlook for US interest rates is the massive kick up US inflation would experience if “the Donald” gets his way with his promised policies on import tariffs and a weaker US dollar exchange rate. He wants to reduce the US’s external trade deficit be making imports more expensive and locally manufactured goods more competitive. However, a double whammy of a weaker US dollar exchange rate and border taxes would send inflation sharply higher. The end result is the Fed pushing up interest rates faster than what the economy can handle and GDP growth stalling. Stagflation and job losses is not what Trump voters signed up for, however that is precisely what would happen if Trump implements the weaker dollar and import tariffs together. The reality is more likely that he will be forced to back-track on both policy pledges. The global forex markets are now almost completely ignoring (as they should!) the Trump tweets on the dollar’s value.

Market pricing of the timing of when short-term interest rates increase in New Zealand next year may well receive an early indicator this Thursday with the release of the CPI inflation rate for the March quarter. A quarterly increase well above the +0.7% consensus forecasts would have annual inflation above 2.00% much earlier than the RBNZ anticipated. Much depends on whether food and fuel prices will reverse back down over the remaining quarters of 2017.

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