Investors are piling into risk assets from small-cap stocks to cryptocurrencies in a “wildly bullish” market response to Donald Trump’s presidential election victory last week, even as strategists warn of mounting dangers in the US Treasury market.
The broad-based rally, driven by expectations of corporate tax cuts and financial deregulation, has triggered one of the most dramatic market rotations since the 2008 financial crisis, though a sharp sell-off in government bonds threatens to challenge the optimism.
“US treasuries have been under pressure, sending yields higher in the bond market. This weakens sentiment in the bond market, which could be dangerous for riskier assets if yields rise further,” John Hardy, Chief Macro Strategist at Saxo Bank, told Arabian Business.
The warning signals are emerging even as US small-cap stocks and banks extend their gains, with investors betting heavily on Trump’s campaign promises of lower corporate taxes and a rollback of post-financial crisis regulations.
A strengthening dollar has amplified these concerns, particularly for emerging markets already nervous about Trump’s protectionist rhetoric.
“A stronger US dollar means tighter financial conditions,” Hardy said, noting the currency’s role as the world’s primary reserve currency magnifies its impact beyond US borders.
Fiscal fears
The market’s focus has shifted to the potential impact of Trump’s fiscal policies on the US deficit, already a source of concern for bond investors.
“There are risks as well as potential rewards for investors – especially from tariffs if the Trump administration follows through with anything resembling the scale he has threatened,” Hardy said.
His comments come as investors grapple with the possibility that Trump’s policies could significantly expand “the already very large deficits.”
Sector rotation
Despite the headwinds, certain sectors stand to benefit from the new administration’s policies. Construction companies could see increased demand as the US potentially builds up domestic manufacturing capacity in response to protective tariffs.
“Other sectors that might do well could be…US-based companies that will enjoy protection from foreign competition and, therefore, higher profits – this could be in US cars and other consumer product categories,” Hardy said.
Banks in particular could see sustained gains from deregulation “that allows them to leverage their operations more, by avoiding some of the stricter capital reserve requirements that have come in the wake of the GFC,” he added.
However, this optimism comes with a crucial caveat: the benefits could evaporate if tariffs and/or spiking US interest rates derail the economy and send it into recession.
Spending concerns
Additional risks loom from potential spending cuts. “If Trump cuts spending as he has threatened to do, this could represent a short-term headwind for GDP growth,” Hardy said.
The complex interplay of these factors has created what some analysts see as a precarious market environment, despite the current optimism.
With cryptocurrencies and other speculative assets drawing fresh investment flows, some market veterans are advocating for caution.
“Given wildly bullish sentiment, I would just note that we should keep a balanced outlook,” Hardy said.
The market reactions come as investors recalibrate their portfolios for what could be a significant shift in US economic policy, with implications for global markets and trade relationships.
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