Financial markets don't typically start pricing in possible election outcomes until a month or two before Election Day, but this year is an exception.
The 10-year Treasury yield has risen about 10 basis points, or 0.1 percentage point, since June 27. That may not sound like much, but it is a reversal of a downward trend in recent weeks as very tame inflation data fueled expectations of a rate cut by the Federal Reserve.
Investors’ interest rate outlook appeared to change around June 27, when President Joe Biden gave a poor and at times incoherent first presidential debate with former President Donald Trump.
Biden's performance was so disturbing that it quickly changed the electoral landscape, with the market seeing an increasing chance of Trump winning, but more importantly for the market, an increased chance that Trump would win the election and that the Republicans would control both the House and Senate. The market cares more about this because the president cannot implement his entire agenda unless Congress can pass legislation he supports. Economist Rosenberg wrote in a July 3 analysis:
“It’s all about bond investors starting to price in the possibility not only that Trump will win but that Republicans will control both houses of Congress.”
Trump, a real estate developer who once called himself the “King of Debt,” prefers the lowest possible interest rates, but Wall Street believes his policies in a second term are more likely to push rates higher than lower.
There are several reasons for this. First, Trump wants to impose new tariffs on imported goods, which will increase the prices of thousands of everyday items and will drive up inflation, not to mention tight global energy markets and shipping disruptions in the Red Sea, which are now more intense than when Trump was president from 2017 to 2021.
In 2022, the Fed began rapidly raising short-term interest rates to counter inflation peaking at 9% that year, but stopped raising rates in the summer, and inflation is now 3.3% in the U.S. Recent data suggest that if nothing changes, inflation is likely to continue to fall, and the Fed could begin gradually cutting interest rates in the fall, which would benefit home and car buyers and many other borrowers.
But if Trump inflation emerges, the Fed may prevent or delay rate cuts, even if Trump could win the election in November. If "Trump inflation" does occur, the Fed may have to raise interest rates rather than lower them.
Trump also wants to cut the corporate tax rate by another percentage point and extend individual tax cuts that are set to expire at the end of 2025. Those moves would force the Treasury to issue more debt than currently forecast, further increasing the record federal deficit.
With so much supply of Treasuries on the market, Treasury auctions have seen some unsettling volatility in recent months, and if the Treasury issues more Treasuries, it could trigger the debt crisis that many analysts have been anticipating for years.
If there aren't enough buyers for all the debt the Treasury issues, Treasury yields have to rise to attract buyers. When Treasury yields rise, all borrowing rates rise at the same time.
Since the June 27 debate, the rise in 10-year yields has become more pronounced, until Federal Reserve Chairman Powell made optimistic remarks on the inflation outlook on July 2, which caused long-term U.S. Treasury yields to fall slightly and rekindled market hopes for a rate cut in September.
But there is still a "Trump premium" in the market. If Trump does win the election, the U.S. bond market is likely to enter a "wartime state" from the first day of Trump's presidency. Trump has long criticized the Federal Reserve and its chairman Powell for not lowering interest rates lower.
Inflationary pressures are stronger today, and that won’t change if Biden leaves office because many of the pressures come from outside the United States.
If Trump manages to get the Fed to lower interest rates, the result will likely be higher inflation, which will also spark voter anger against him, as is currently the case with Biden's declining approval ratings. Voters may have to wait until 2025 to see this, but the market has already seen it as a major warning.
Article forwarded from: Jinshi Data
