Trump’s growth strategy scaring bond investors
Donald Trump’s promise of doubling US economic growth has made bond investors run to the exit door. The bond market is sending the president-elect a simple and unambiguous warning: be careful, or it’s going to cost you more than what you are going to get. The US’s financing costs have unexpectedly soared in the days after the billionaire won the election with a mix of populist rhetoric and promises to cut taxes and spend big on infrastructure.
Yields on US Treasuries jumped, contributing to the biggest increase since the taper tantrum. Part of the bond-market selloff, of course, has to do with expectations Trump’s fiscally expansive, pro-growth agenda will spur faster inflation. But crucially, it serves as a not so subtle reminder that America’s creditors can still wield considerable power to constrain public spending, and force the incoming administration into making some hard choices about the proposals it can and cannot afford.
Tax cuts and doubling of US Gross Domestic Product under Donald Trump would widen the deficit further. Something that has happened before. Under Bill Clinton, bond investors forced him to scale back on his promises of tax cuts and focus more on reducing the budget deficit. Bill Clinton spent his first term in office reducing the deficit, which he successfully managed to do so.
Donald Trump has all these big spending plans, but he doesn’t have the correct revenue to pay for it. Meanwhile, bond investors are not taking the risk. As short and long-term interest rates go up, US funding costs go up and deficits get worse. He will face reality in the months ahead and will realize that he will not be able to afford to deliver all he promised during his presidential campaign.
The details of his economic policy haven’t all been announced yet, but as part of his plan to jump-start the US economy, Trump has pledged to reduce personal taxes across the board, reduce corporate taxes to 15 percent from 35 percent and spend $1 trillion to rebuild and improve the nation’s crumbling infrastructure. Some costs would be offset by a one-time repatriation tax of 10 percent for companies, which hold some $2.6 trillion abroad.
His promise of building a wall along the US border with Mexico to stop illegal and undocumented immigrants cross into the US will add to the costs immensely. To see other stories detailing the US fiscal outlook, so far, no one is suggesting Trump will face the same degree of pushback from the bond market that Clinton confronted in 1994.
Bond supply, demand
I think the bond market situation might be starting to change. US Treasury 30-year bond yields climbed six basis points, or 0.06 percentage point, to 3.00 percent on last, Monday. Going the through the 3 percent level for the first time since the start of the year. The US 10year Treasury bond’s yield jumped 37 basis points last week, the most since June 2013. The yield climbed another seven basis points on last Monday to 2.23 percent. These kind of moves was short and sharp and hardly any investor saw it coming.
Concerns about big spending under Trump will widen the budget deficit and lead to faster inflation. This has already prompted some investors to step back from buying US Treasuries. On the day following his victory, demand at the government’s sale of $23 billion of 10-year notes fell to the lowest since 2009. More fiscal policy would possibly also cause more issuance, which is already impacting markets.
A steady and continuous retreat, especially by foreign investors who have been the biggest source of demand in the $13.8 trillion Treasury market, could potentially undermine Trump’s spending plans even before he takes office.
The new administration under Donald Trump will need to cough up with another extra $10 trillion of debt to cover the rising cost of programs like Social Security and Medicare over the next decade, according to the Congressional Budget Office. For the next few months, I strongly recommend that investors diversify away from fixed income if they can. The bond Bull Run which has lasted for more than two decades will have to come to an end at one point, but the victory of Trump probably brings this on earlier than previously thought.
I wouldn’t be surprised if 10-year yields keeps on rising in the coming months or even years. It will be up to the Federal Reserve to stop it from rising too much. It all depends on the future inflation outlook that has been rising too. The threat of higher borrowing costs may do little to deter Trump’s ambitions. As a businessman, he often used high-cost debt to fuel expansion at his casinos and hotels, even as some defaulted on bondholders and others ended up in bankruptcy. In May, Trump said that if the economy were in a prolonged slump, he might use his business skills to push America’s creditors to accept write-downs on their government debt.
US Congress being totally Republican, he might not be able to get fiscal policy through quite easily. Even if investors give Trump the green light, fiscal conservatives in his own party might not. Led by the Tea Party faction, congressional Republicans have clashed numerous times with Obama over spending priorities and the doubling of the national debt under his administration’s watch. But now, more
debt-financed spending is what Trump and his advisers are advocating to spur the economy. In October, Trump claimed his plan would unleash growth of 5 percent or 6 percent, about double today’s pace.
Whatever the case, keeping the bond market on board will be key. In recent years, the global savings glut and rock-bottom rates helped keep Treasuries in demand. But any misstep now could be disastrous. Based on duration, a one percentage point increase in yields would lead to more than $400 billion in losses, which might cause investors to push borrowing costs even higher. That could have lasting consequences on Trump’s ability to get America back on track.