"Bond Guardian" is watching closely! Shorting U.S. stocks will become the next stop for the "Trump Trade"?

According to Zhitong Finance APP, after Trump won the U.S. presidential election, stock investors, cryptocurrency investors, and dollar bulls were excited about Trump's promises to relax regulations and cut taxes during his campaign. However, the economic policies Trump plans to implement upon returning to the White House could lead to soaring budget deficits and inflation, which makes bond investors uneasy.

Trump's ability to win the U.S. presidential election was largely due to the importance of the economy in this election. Despite strong economic growth, a low unemployment rate, and a decline in inflation, voters punished the Democratic Party, which has been in power for the past four years, due to the sharp rise in the cost of living.

Official data shows that current consumer prices in the U.S. are 21% higher than when Biden won the election in 2022. In the 10 key states that helped Trump return to the White House, three-quarters of voters reported that inflation had caused them moderate or severe difficulties over the past year. Most of these voters cast their ballots for the Republican Party.

Ironically, the economic policies Trump plans to implement may exacerbate inflation. Trump has promised to impose a 10% tariff on all imported goods and a 60% tariff on goods imported from China. Dario Perkins, an analyst at investment bank TS Lombard, pointed out that this level of tariff increase would raise the effective tariff on U.S. imports from the current 2% to about 17%, the highest level since the 1940s. According to his calculations, this would increase the consumer price index by 1.3 percentage points, equivalent to a 20% rise in oil prices. The U.S. CPI year-on-year increase in October has already rebounded to 2.6%, above the Federal Reserve's target of 2%.

On the other hand, stock investors seem to be less concerned. The S&P 500 index surged significantly after Trump's victory, and although it has since retraced some gains, it remains above pre-election levels. Stock investors believe that Trump's relaxation of regulations across many industries could trigger a wave of mergers and acquisitions. Meanwhile, fund managers are also fond of Trump's idea of lowering the corporate tax rate from 21% to 15%. Goldman Sachs stated that this would increase the average earnings per share of S&P 500 constituent companies by 4%. The Russell 2000 index, composed of small-cap stocks, is also favored by investors, partly because they believe Trump's trade protectionism will benefit these small companies focused on the domestic U.S. market.

In addition to the stock market, cryptocurrencies have also risen due to Trump's support for the industry. It is understandable that investors are flocking to risk assets such as stocks and cryptocurrencies, as fiscal easing and the Federal Reserve being in a rate-cutting cycle may further boost an already exciting economic growth rate. The International Monetary Fund (IMF) expects that the U.S. Gross Domestic Product (GDP) will grow by 2.8% this year and by 2.2% in 2025, with growth rates far exceeding those of many other Western countries.

However, the cost of this growth will primarily be borne by the U.S. Treasury. According to data from the nonpartisan Committee for a Responsible Federal Budget, Trump's policies could increase the U.S. budget deficit by $15.5 trillion over the next decade. Given that the current U.S. budget deficit already exceeds 7% of GDP, such fiscal extravagance may raise questions about the sustainability of U.S. finances.

Bond investors have undoubtedly taken note of this. The yield on the benchmark 10-year U.S. Treasury bond has risen from 3.6% in September to around 4.4% currently. On one hand, investors are concerned that the policies Trump will implement will trigger a resurgence of inflation and force the Federal Reserve to keep interest rates at elevated levels. On the other hand, investors are seeking higher returns to compensate for the risks associated with higher debt levels.

"Bond vigilantes" refer to those investors who lower bond prices, raise bond yields, and successfully force governments and central banks to change policies. Ed Yardeni, a veteran strategist on Wall Street who first coined the term "bond vigilantes" in the 1980s, stated, "Trump's high approval ratings give him significant influence not only in the U.S. but globally, and it is reasonable for the bond market to be concerned about continued fiscal easing given the already large budget deficit." Ed Yardeni noted that "bond vigilantes" are dominating the market, and they may push the 10-year U.S. Treasury yield up to 5%, thereby affecting the Federal Reserve's subsequent rate-cutting actions.

Nouriel Roubini, a well-known economist nicknamed "Dr. Doom," pointed out that if Trump returns to the White House and continues his massive spending plans, it could lead to the return of the "bond vigilantes," which may suppress "radical" economic policies. Roubini stated, "Trump cares about market discipline; if bond yields rise and the stock market adjusts, the bond vigilantes will say your policies are unsustainable—then economic advisors will warn him against adopting radical populist economic policies and suggest a more moderate approach."

Despite optimists believing that the U.S. Treasury market can withstand such shocks, as the dollar, being the most important global currency, ensures strong foreign demand for U.S. Treasury bonds and other assets, the issue is that rising bond yields weaken the rationale for investors to hold stocks. If held to maturity, bonds are undoubtedly a safer asset than stocks, and high bond returns can attract investors away from equities. Especially when benchmark stock indices like the S&P 500 are at overvalued levels, higher bond yields mean a higher discount rate for future cash flows, which will reduce the present value of stocks Of course, the eloquent Trump may go back on his campaign promises after taking office in the White House, or choose not to fulfill his commitments if he sees poor economic and market performance. However, if Trump acts according to his previous promises, the next target of the "Trump trade" may be to short the stocks that have been strong performers so far