Crypto News: It's not just the "Trump Trade". It's the Goldilocks Trade too

As the US presidential election remains a toss-up right down to the wire, a lot of people are talking about moves in US asset prices as a "Trump Trade." Yet I'm not so sure that's what we're seeing. True, higher interest rates and a rise in gold, Bitcoin and equities is consistent with what traders should bet on if they're expecting the now crypto- and tariff-loving Republican to return to the White House and cut taxes, adding stimulus to an economy the Federal Reserve is still trying to cool down. But it arguably also is what traders should be betting on based on where the economy is heading already — which, increasingly, looks like the Goldilocks scenario of a soft landing.

As high as the stakes are in this election, it's also important not to forget that the fundamental drivers of asset prices are things like consumption, economic growth, inflation and individual company performance. And to the degree the economy's best-case outcome becomes so good that it threatens to stoke inflation and engender higher interest rates — irrespective of who's in the White House — that's something that will make it's way into the market price of financial assets. And we see that with consistently high inflation expectations.

So there are signs that point to disquiet about inflation or US government deficit spending turning a Goldilocks outcome into something a bit more sinister. We can see that in rising bond yields and something called the term premium, which I consider to be the real wildcard that could put a dent in asset prices and economic growth to boot.

As always, let me share a crib sheet of points I want to make first:

The rise in the term premium on bonds, an often overlooked financial market gauge, is telling us people are worried about government debt, inflation or both
There is a technical threshold from earlier this year just a step away. But after that yields could go much higher.
Luckily this is just a small 'tail' risk. The base case has to be continued (and hopefully more inclusive) growth. And you can see that in other asset prices.

Back in 2013, when the Federal Reserve was led by Ben Bernanke, he gave an important speech to bolster the Fed's image. This was in the wake of the Great Financial Crisis and multiple rounds large scale asset purchases by the Fed and during the European Sovereign Debt Crisis. Bernanke promised ever greater transparency for how the Fed makes decisions, outlining specifically how he thinks about the Fed's policy tools and communications.

One of the more important things he said was about the term premium:

it is useful to decompose longer-term interest rates into two components: One reflects the expected path of short-term interest rates, and the other is called a term premium. The term premium is the extra return that investors require to be willing to hold a longer-term security to maturity compared with the expected yield from rolling over short-term securities for the same period.

Translation: The only thing you really need to know about bonds is what the market thinks future interest rates will be and how much more yield investors will receive for taking on the risk of longer maturity bonds. That's it. If you know those two things, then you can place an informed bet accordingly.

As it turns out though, the European Sovereign Debt Crisis was so wrenching and the demand for safe assets so large that the premiums Bernanke mentioned that the US government had to pay for longer maturity debt became discounts.

The premium had been declining for years. But it was that loss of confidence in the bonds from countries like Italy, Ireland, Spain, Portugal and Greece that had investors clamoring for US Treasuries to the degree that they were willing to pay more than what average expected future interest rates would have dictated. In a sense, to lock in a return on a safe asset, people were paying more than that asset was worth. And when the pandemic hit, that willingness hit an extreme, which — combined with the Fed's zero percent policy rate — brought long-term Treasury yields to stunningly low levels.

That was great for big corporations and wealthy and upper middle-class homeowners who locked in low debt payments. But when the Fed started raising interest rates, not only did the base rates go up, so did the term premium. Locking in a safe asset for 10 years when you didn't know the direction of inflation or interest rates seems like a fool's errand. And investors holding those assets got burned. Famously, Silicon Valley Bank went bankrupt because of it.

So, where are we now? Right now, the term premium is rising at a fast clip as the US economy has avoided a recession and the torrent of debt from US deficit spending increases. Take a look at this chart from the US Treasury Department's website:

Excluding the huge and necessary deficits of pandemic years 2020 and 2021, it shows deficits increasing every year since 2015. What's more, both major presidential candidates, Kamala Harris and Donald Trump, have economic plans that will keep this trend going. Harris' plans are not as deficit-inducing because she wants to increase some taxes on the rich and corporations. Trump's plan really makes him the "King of Debt." And that's a big reason people are talking about soaring yields, soaring Bitcoin and soaring gold prices as Trump trades.

$7.75 trillion

- the increase in federal government debt over 10 years as estimated by the Committee for a Responsible Federal Budget under plans floated by Presidential candidate Donald Trump

First of all, we don't know if Donald Trump will win the election. We may not even know next Wednesday when the next edition of this newsletter comes out. But all of the trends we see as Trump Trades have been in place for months. Moreover, they continued even after Kamala Harris initially erased the advantage former President Trump had garnered over President Biden.

Take Bitcoin, for example. Its value collapsed along with high beta equities as it became clear inflation was so high, the Fed was going to raise interest rates considerably. But even as the Fed was raising interest rates (and inflation was slowing), these volatile assets started to rise in anticipation of an end to rate hikes and the potential for a soft landing. That narrative took on water earlier this year as negative economic surprises surged. But Bitcoin and the Nasdaq 100 is back to record or near-record levels.

That's Goldilocks driving price action, not Trump. Same for gold. That uptrend has been in place for two years as the US economy has powered forward. Much like gold's last push higher, it's coming during good economic times and rising US deficits. The uncertainty surrounding the pandemic arrested gold's climb. But once the potentially inflationary trend of ever higher deficits and high growth became clear, gold started rising again.

And so, we can say the same thing with bond yields. There is no longer a dearth of safe assets. Now the threat is too many of them. And the term premium is rising as a result. Go back to that first chart and look at the levels that prevailed in the 1990s and 2000s before the Great Financial Crisis. Back then, investors regularly demanded 1, 2 or even 3% for taking the risk of fixed income for a longer maturity. In 1992, that number was even 4%.

So imagine a world in which the US economy is doing just fine, earnings are rising inline with GDP and job growth continues apace. That's the world we're in now. So we don't have to imagine it. But imagine what that Goldilocks outcome turns into if the economy overheats under a deluge of government debt. In the near-term, the term premium's high is just a quarter percentage point higher. That equates to about 4.50% yield on the 10-year bond. But, if we go back to 1% or 2% term premium, suddenly we're talking 5% or 6% 10-year yields. And that's high enough to unravel the Goldilocks outcome, especially since future fed funds rates would likely make yields even higher.

In the past I've talked about left-tail risks — bad economic outcomes at the extreme left tail of the curve of future possibilities. This is actually a right-tail risk, a good economy outcome that's so extreme it's bad. And the triggering factor here is deficits.

In the here and now, we've had a good earnings season and continue to see upside economic surprises. Private payrolls were up double the expected amount and consumer spending in the quarter just ended was up 3.7% even after taking inflation into account. It doesn't get much better than this. And budget-busting tax cuts and government spending are the most likely things to derail Goldilocks.

The Atlanta Fed's GDPNow got it exactly right on GDP. The thing to note though was the 3.7% rise in consumption last quarter.
I don't put huge stock in individual ADP payrolls figures. Still it was double estimates. And over time those numbers tend to average out to mirror the official ones.
On the other side of the coin, commercial real estate woes continue apace. Note this doesn't include US retail.

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