Updated: 05-02-2016

Deficit Scolds May Be Losing Influence
Updated: 29-Apr-16  04:21PM ET
Analyst: David Kelland

While I admit that I am something of a political junkie, politics ('sports for nerds,' as John Oliver calls it) is not usually relevant to interest rates. This week, however, there were some political developments that bear watching.

First, Donald Trump won 41 unbound delegates in Pennsylvania, virtually crushing Senator Cruz's hopes for eking out a win on multiple ballots at the Republican National Convention. Trump now trades in prediction markets at an 82% chance for the GOP nomination. What that means is that we will very likely have a person in the White House come January 2017 who believes in increasing borrowing to take advantage of low interest rates.

Second, Trump has been bucking more Republican orthodoxy and winning plaudits in the unlikeliest of corners. Narayana Kocherlakota, former president of the Minneapolis Fed, penned a piece on Bloomberg this week entitled, Trump Starts Making Economic Sense.

While many of the Republican presidential contenders have been subscribing to economics of a more *Taylor-esque or even Austrian bent, Trump has embraced low interest rates, saying, 'If rates are 3% or 4% or whatever, you start adding that kind of number to an already reasonably crippled economy in terms of what we produce, that number is a very scary number.' He went on to say that low rates are an opportunity for the federal government to borrow to rebuild infrastructure and the military.

Of course, betting markets say that Hillary Clinton has a 66% chance of winning the presidency, but she may face a Congress that is more sympathetic to infrastructure investment than the present one. Members of Congress may read a warning into Trump's nomination that gridlock in the name of party loyalty is going to imperil their careers. Fiscal stimulus has been off the table since the 2010 midterm elections gave the Republicans control of the House of Representatives and the mere possibility for more borrowing is not being talked about in the media.

To more prosaic matters, last week I mentioned that the sharp sell-off in Treasuries had not really been consolidated and that it was prone to reversal. I'm not crowing now, but just wary of selling again. The sell-off over the past two weeks was fairly sharp and it may be some time before the bulls can be caught offguard again. The best level I can see is support at 2.619-2.624% in the 30-year yield (see chart below). The U.S. economic data continues to be bad, and maybe the better trades are in betting on the Italian 10-year yield retesting - and possibly breaking above - its 200-day moving average at 1.60% or buying euro, which I've been discussing for months. The balance of economic data and the direction of monetary policy appear to be moving in favor of the eurozone over the U.S.

*John Taylor, inventor of the Taylor rule and perennial hawk

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