Trump’s growth strat­egy scar­ing bond in­vestors

Kuwait Times - - BUSINESS - By Haider Taw­fik

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.

Cost Ben­e­fit

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.

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