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Trump’s 2016 Win Shook Markets. Traders Won’t Get Fooled Again.

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(Bloomberg) — Donald Trump’s surprise victory in the 2016 presidential election delivered a shock to financial markets. If he manages to secure a second one, traders will — if anything — be far more prepared.

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Trump seems to be on a quicker path to the nomination than eight years ago, when he didn’t lock it down until May. And polls show it would likely be a close contest between him and President Joe Biden, a shift from his long-shot status in 2016.

The result: Wall Street is already starting to game out the impact of Trump’s possible return to the White House.

“This time the markets will be aware of both possibilities and price them to some extent — we wouldn’t expect the same volatility as we saw in 2016 after the election,” said Daniel Tobon, head of G10 FX strategy at Citigroup Global Markets.

Nothing is assured, of course, and Trump’s prospects risk being upended by the ongoing criminal cases against him or a surprise turn of events at the polls. That’s made the election little more than background noise so far — for markets, at least, with the focus instead squarely on the trajectory of the economy, geopolitical tensions and when the Federal Reserve will start cutting interest rates.

But something of an early consensus is emerging, based in part on what happened last time around and the likely impacts of the few policies he’s staked out so far — like imposing 10% tariffs on imports and making his 2017 individual tax cuts permanent. The upshot is that it could put upward pressure on bond yields, bolster the dollar, and exert a drag on trading partners’ currencies.

Here’s a look at the market reaction to Trump’s 2016 victory and how it could play out if he heads to a second win this year:

Bond Rally’s Fate

The US bond market is facing a far different dynamic than in 2016, when the central bank had just raised interest rates for the first time of its cycle and was poised to keep doing so. Those expectations — combined with a view that Trump’s tax cut plans would stimulate the economy — contributed to a deep bond-market selloff, pushing up 10-year Treasury yields in the fourth quarter by the most in more than seven years. Bond funds saw the largest outflows of cash since 2013’s “taper tantrum.”

The question this time around is to what degree Trump’s proposed policies — either as his party’s nominee or the incoming president — could alter the interest-rate cut expectations that are now priced into markets.

“It’s about tax and growth implications, deficit implications, regulatory implications, because that’s quite crucial for markets,” said Gennadiy Goldberg, head of US rates strategy at TD Securities.

But the fiscal impact of the election will likely be seen as more muted this time, in part because a key issue will be whether to extend Trump’s 2017 tax cuts when they expire next year, not necessarily pushing through new ones. Furthermore, Biden has been overseeing an expansionary fiscal policy, leaving the government already contending with large deficits at a time of near full employment.

“Which one of these candidates is likely to generate a higher deficit? The way things stand, it’s currently both,” Goldberg said. “A lot of this comes down to what the fiscal trajectory is in the US, and right now there’s no push for fiscal conservatism. That’s making investors nervous about 2025 and 2026.”

Whether the next president’s party controls Congress or not is also key, since a divided government may result in gridlock.

Goldman Sachs Group Inc.’s Dominic Wilson and Vickie Chang said in a note to clients that it looks more likely that Republicans — not Democrats — could win control of both the White House and Congress. Such a sweep, they said, could result in higher bond yields — particularly on longer-dated securities — by keeping the Fed on guard for a potential overheating in the economy.

Strong Dollar?

Higher yields could be good for the dollar. The currency drifted lower as bond yields retreated from last year’s peaks due to expectations for rate cuts, leaving it holding well below its 2022 high.

While the dollar surged after Trump’s 2016 victory as Treasury yields jumped, it went on to slide in 2017 as the U.S. economy lost momentum while growth picked up in Europe.

But Trump’s push to impose tariffs — if successful — could help boost the dollar against other currencies by curbing imports and stanching the flow of dollars outside of the US.

“The Trump effect is in part by default dollar positive, precisely because it’s negative for important currencies like the euro, yuan and Mexican peso,” said Deutsche Bank strategist Alan Ruskin. “Traders are recognizing that Trump’s impact on trade and geopolitics is for different reasons, at least initially, positive for the dollar.”

The Mexican peso, which rallied last year, slipped some 2% on Tuesday as investors adapted to the news of Trump’s Iowa victory. The Chinese yuan is also expected to face added pressure if a Trump victory looks likely as the election nears.

Deutsche Bank strategists wrote in a note to clients that the election will likely keep the dollar in 2023’s ranges this year even if the Fed cuts interest rates as sharply as expected. “The market is likely to start adding to a dollar safe-haven premium through the year as election risks build,” they wrote.

Stocks in Limbo

The US stock market rebound — which drove the S&P 500 back to a record high Friday — is hanging more than anything on whether the Fed can dial back interest rates and pull the economy into a soft landing instead of a recession.

In early 2016, the global stock markets were arguably on a more shaky footing than they are now, contending with the specter of rising rates instead and a world-wide oil glut. In August 2015, China’s decision to devalue the yuan set off an equity rout there that rippled to other markets, and the UK’s vote to pull out of the European Union dealt another shock in mid-2016. Even so, the S&P 500 drifted up for most of that year and jumped in the two months after Trump’s victory.

Some corners fared better under Trump than others, with his America First rhetoric and pledge to bolster US defense spending lifting defense contractors like Lockheed Martin Corp. and Northrop Grumman Corp. While Trump fell short on his promise to enact a major infrastructure plan, Caterpillar Inc., the maker of signature yellow diggers and bulldozers, more than doubled during his tenure. But overall, the so-called Trump trades of 2016 lagged the S&P 500 during his term.

That’s left investors wary of trying to predict equity-market winners and losers at this stage, particularly since macro-economic forces are overriding election talk.

“Political predictions and the market don’t seem to match up at this point” said Joseph Saluzzi, co-head of equity trading at Themis Trading LLC. “At this point of the economic cycle, it’s impossible to say that the market reactions are based on political predictions. You bet on coal stocks, you bet on financials, you bet on infrastructure stocks — the markets will find a way to make you look like an idiot.”

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