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Old Mutual: US rates must rise to stem bond market sell off

Old Mutual: US rates must rise to stem bond market sell off

Old Mutual Global Investors has warned a bond market sell off following the victory of Donald Trump is only likely to be stemmed by a rate hike as concern grows over the economic impact of last week's shock election result.

Christine Johnson, head of fixed income at the investment house said that the first few weeks of a Trump presidency will be crucial to the health of the bond market.

She said that despite the naysayers, the future of the US economy and the impact it has on global stability may not be as catastrophic as some have predicted and that Trump's economic policies, although "certainly inflationary", fly in the face of the "popular dogma of prudence and central bank dominance".

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"Currently the expectations for US Federal Reserve interest rate increases have risen, but only very marginally. This is why much of the weakness in bond markets has been felt in the inflation-driven, long end of the yield curve – the market is trying to anticipate a big overshoot in inflation on the expectation the Fed lets the economy run hot", she said. 

"The Fed must raise rates now, while the market must start pricing in a sharper climb in rates next year. This should actually help start a bond rally that would pay for Trump’s fiscal expansion. Simply put, more rate rises now equal less inflation later on, prompting the yield curve to flatten as rate expectations are priced in. This would reward savers for saving, create an incentive to invest and drag down the long end, which is where the Federal government will likely fund itself.

"As a side effect, it would also stop the spinning upward ascendancy of the dollar, which is currently in danger of derailing growth in the rest of the world," she added. 

"The sell off is not quite over, but its shape should start to change. All eyes are on whether Fed chair Janet Yellen and her team grasp this opportunity."

On Monday, US bond yields shot up again. The benchmark US Treasury note hit 2.30% up from 1.86% in the days following the election.

Some of Europe's major stock markets were down after the announcement that the Republican candidate had beaten Hillary Clinton. The FTSE 100 was down 1.2 per cent while Germany's Dax was down 1.77 per cent and France's Cac 40 was down 1.4 per cent.

But several days after the industry-heavy Dow Jones Industrial Average has jumped to a record high, after Mr Trump pledged to cut taxes and deliver a package of infrastructure spending, raising hopes of higher corporate profits.