WASHINGTON, Dec 18 (Reuters Breakingviews): Donald Trump has bullied and bluffed his way through boardrooms, backrooms, newsrooms, courtrooms and even the White House Situation Room. There's no room, however, for his blustering bravado in the bond market.
The president-elect's policy agenda is clear. He campaigned on charging higher duties for imported goods, deporting millions of illegal immigrants and slashing taxes for Americans ranging from bartenders to parents to Social Security recipients. The combined inflationary effects of such steps are almost certain to be far steeper than any savings that can be found by the government efficiency commission led by billionaire Elon Musk and biotech entrepreneur Vivek Ramaswamy.
Although fiscal rectitude has largely gone out of fashion, there are limits to the amount of spending that lenders to the United States will tolerate. World leaders, including former UK Prime Minister Liz Truss, learned that lesson the hard way. If Trump follows through with his profligate plans, he will soon do the same.
Republicans and Democrats alike have drifted away from the sorts of endless budget debates that consumed the Obama administration. And it shows. Federal debt has soared, opens new tab 75 per cent, to about $35 trillion, from less than $20 trillion when Trump first won election in 2016. Three main events explain the surge: his signature tax cuts; pandemic relief and recovery spending; and the trio of infrastructure and industrial packages enacted under President Joe Biden. The US debt to GDP ratio now sits at 120 per cent, with the fiscal 2024 deficit tallying $1.8 trillion.
The sums are destined to rise, and investors know it. Yields on 10-year Treasury bonds jumped to approximately 4.5 per cent in the week after the Nov. 5 election when it became clear that Republicans would control both congressional chambers, too. The increase was from 3.6 per cent in mid-September, when Democratic contender Kamala Harris was riding higher in the polls. With nearly $8 trillion, opens new tab of additional borrowing needed to pay for Trump's tariffs and tax cuts alone over the next decade, as estimated by the nonpartisan Committee for a Responsible Federal Budget, it's no wonder buyers of US debt are already extracting a higher price.
Bond yields also tend to move in the same direction as interest rates. The Federal Reserve only just started to lower them, having quashed rocketing prices by raising the benchmark federal funds rate to more than 5 per cent. Faced with higher inflationary pressures, the central bank probably would have to scale back plans for another 1 percentage point reduction in 2025. In anticipation of such changes, traders would push yields even higher, thus making US debt even more costly to issue.
Political strategist James Carville's stated desire to be reborn as the bond market, because "you can intimidate everybody," holds up. Just ask Britain's Conservative Party. A head of lettuce famously outlasted Prime Minister Liz Truss after debt investors revolted against her budget proposal, pushing the pound to its weakest level against the dollar and one-year gilt yields to their biggest single-day spike. After having been elected by a small group of party insiders, she was ejected by the Invisible Hand.
Carville's reincarnation inspiration was from his time working for President Bill Clinton. In 1993, 10-year US Treasury yields surged nearly 3 percentage points in a year, in what became known as the Great Bond Massacre. At the time, the deficit equaled 3.7 per cent of GDP, compared to 6.2 per cent in 2023. Just a few years later, the country was running budget surpluses, authorities having been sufficiently spooked into fiscal probity.
As the keeper of the world's reserve currency and its largest economy, the United States has some built-in advantages when it comes to hawking, opens new tab its debt instruments. There's little chance a government bond auction would fail, per se, in part because primary dealers such as banks are required to bid. But a credit downgrade or outburst from a small group of so-called bond vigilantes is all it would take to weaken demand and push yields higher.
Such conditions could lead banks to book losses on their portfolios and cause markets to seize up in a more extreme version of what happened during Silicon Valley Bank's meltdown in 2023. Any capital restraints also would threaten to derail economic growth by curbing loan activity, including residential mortgages. Any such reaction from investors would get the attention of the Treasury Department and congressional leaders, even if Trump himself were to stubbornly cling to his campaign promises.
The president's track record suggests he might try to browbeat the Republican leadership into complying with his wishes in defiance of what investors are signaling. At that point, it would probably be a matter of targeting tariffs more precisely and relenting on the size and reach of any tax cuts. Always being on the attack partly explains Trump's achievements, but in 2025 he'll meet his match in the bond market.
