Could the bond market stymie Trump’s economic plans?
Bond investors are concerned that the Federal Reserve may continue lowering rates while the economy is growing robustly, risking more inflation
WITH Republicans poised to seize control of Congress, Donald Trump’s economic plans could face little legislative resistance. The president-elect has vowed to escalate tariffs, extend a corporate tax cut and introduce tax breaks on tips and Social Security benefits, policies that some fiscal hawks worry would increase the federal deficit and with it, inflation.
But even if Trump faces meagre resistance on Capitol Hill, another force may temper his policies: the bond market.
While stocks just pulled off a record-setting week, with the S&P 500 gaining roughly 5 per cent since Election Day, a volatile bond market signals that investors have some worries that an unchecked Trump agenda might stimulate growth but worsen the country’s debt burden.
“If the Trump administration runs excessively stimulative fiscal policy, with lots of spending and tax cuts, leading to even wider deficits, I think then that may cause the bond vigilantes to push yields up to levels that create problems for the economy,” said Ed Yardeni, president of Yardeni Research.
Yardeni, a veteran Wall Street analyst, coined the term “bond vigilantes” in the 1980s, to describe the influence that frustrated bondholders can have on the policy agendas of politicians and central bankers. He sees a potential for bond vigilantes to pose a risk to the Trump agenda, too.
The US sells Treasury bonds and notes to fund big parts of the federal government. These auctions provide the lifeblood of the US economy, and the yields on Treasuries are viewed as a real-time gauge of the country’s financial health. Yields tend to climb when investors anticipate economic growth may cause inflation to accelerate, and expect the Federal Reserve may have to raise rates to slow the economy. Higher yields mean the government pays more to borrow.
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“You can intimidate everybody”
A spike in bond yields in 2007 signalled trouble in the housing market. A year later, Bear Stearns collapsed. A sell-off in bonds pushed the Clinton administration in the 1990s to ultimately abandon a policy of high-deficit spending.
After that policy reversal, James Carville, President Bill Clinton’s political strategist, quipped that if he were to be reincarnated, he “would want to come back as the bond market. You can intimidate everybody.” Bond vigilantes helped push Liz Truss out of her job as British prime minister in 2022.
Since September, alarm bells have been ringing as the yield on a 10-year Treasury note has jumped roughly 70 basis points – a huge move. That occurred even as the Fed started to cut its benchmark lending rate, with the goal of lowering borrowing costs for businesses and households.
A spike in yields can be problematic for the government and consumers: The average rate on a 30-year mortgage, which tends to trend in line with rates on long-dated Treasury bonds, jumped this past week to the highest level since July, unwinding some of the Fed’s work to bring down borrowing costs.
Bond investors are concerned that the Fed may continue lowering rates while the economy is growing robustly, risking more inflation. They also worry about the US$1.8 trillion deficit, and that Washington is doing little to rein in spending. Trump’s plans, including the tariffs, could add as much as US$7.5 trillion to the debt over the next decade, according to the Congressional Budget Office.
“The vigilantes take law and order into their own hands when they figure the authorities aren’t accomplishing the job they want to see accomplished,” Yardeni said.
Fed chair Jerome Powell this past week downplayed the recent spike in Treasury yields, and suggested the central bank’s outlook for interest rates would not be affected by Trump’s economic plans. But a number of Wall Street economists now think the inflation risk of Trumponomics will be enough to force the Fed to pause interest rate cuts, likely next year. They also see room for yields to go higher unless Washington shows some fiscal restraint.
“I think the bond vigilante risk is still out there,” especially if Trump’s economic plans add to the deficit, said Lawrence Gillum, chief fixed-income strategist for LPL Financial. NYTIMES
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