The Trump administration is judging itself on the wrong market

Traders 1929Getty31st October 1929: In a London club run by St Phalle Ltd, members watch fluctuations in the New York stock market during the Wall Street crash as changes are chalked up by telephone operators in direct contact with New York.

US Treasury Secretary Steven Mnuchin has said stock prices are a good barometer of success for a presidency.

He may have been looking at the wrong market.

Many on Wall Street tend to look at Treasury bonds as the “smart money” when it comes to predicting the future of the economy, because there are fewer retail investors than in the stock market. Additionally, those investors tend to be more sober-eyed and less susceptible to bouts of irrational exuberance.

It’s for that reason that investors should be worried about the recent divergence in messages coming from the stock and bond markets. Even as the S&P 500 rallies to repeated record highs, Treasury bond yields, which move opposite to their price, have steadily fallen, indicating preoccupation with the future, not confidence in it.

The 10-year yield spiked as high as 2.64% in the wake of the election as traders bought into renewed optimism about President Donald Trump’s ability to pass business-friendly legislation through a Republican-controlled Congress. It has since retreated to around 2.40%.

That means investors are betting interest rates are not going to rise as quickly, meaning they foresee an economy that will continue to struggle just to reach growth of around 2%. In other words, while the stock market is rallying, suggesting confidence in economic growth, the “smart money” is doing the opposite.

“Stocks tend to have an optimistic bias, and bond markets a pessimistic bias. One looks at the glass half full, the other at the glass half empty,” said Thomas Costerg, economist at Standard Chartered.

“This may explain that stocks are holding up quite well,” he said, even though “Congress’ failure to repeal the health-care bill is a significant legislative setback that has led investors to reconsider the popular reflation trade, premised on the view that the Trump administration will bring material fiscal easing to the US economy.”

The failure of Trump’s first major piece of legislation reinforces concerns about the underpinnings of the stock rally — the idea that Trump and Republicans Congress would see eye to eye on the big issues. Doubts about the momentum for tax reform are rising after the healthcare showdown exposed previously hidden divisions within the Republican Party.

“The fixed income markets are not showing signs of enthusiasm,” writes FTXM’s Chief Market Strategist Hussein Sayed in a research note. “This explains why the dollar lost much of its value, but more importantly, it indicates that fixed income investors do not see real signs of acceleration in inflation and economic growth.”

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