Republican presidential nominee, former U.S. President Donald Trump complains about his microphone not working properly during a campaign rally at the Fiserv Forum, the same place that hosted last summer’s Republican National Convention, on November 01, 2024 in Milwaukee, Wisconsin.
Chip Somodevilla | Getty Images
The potential that Donald Trump could prevail in the presidential race has contributed to sentiment in financial markets that the firebrand candidate’s policies could stir both economic growth as well as inflation.
In the case that Donald Trump defeats Kamala Harris, some see a scenario in which rising fiscal deficits, along with a potential global trade war, could mean higher inflation and surging bond yields, along with gains in the stock market.
Being that yields and prices move in the opposite direction, that would be bad for underlying fixed income value. Depending on how things trend, there’s even talk about the return of “bond vigilantes” — traders who essentially force the government’s hands by either eschewing government debt or selling it outright.
Investor Ed Yardeni coined the term back in the 1980s, and cautioned that the vigilantes could return. Specifically, he warned about traders taking the 10-year Treasury yield, a bond market benchmark, above 5% — a level it hasn’t seen since mid-2007.
“We aren’t (yet) calling for the 10-year Treasury yield to reach 5%, but the Bond Vigilantes seem to be threatening to take it there,” Yardeni wrote in Monday commentary.
10-year yields
What’s happening in bonds?
To be sure, there are myriad reasons why the bond market has been in a state of tumult since mid-September, political considerations of a second Trump term being just one of them. Consider:
- The Federal Reserve cut its benchmark short-term borrowing rate by half a percentage point on Sept. 18. While that might normally trigger the rest of the yield structure to move lower, it instead kindled expectations of more robust economic growth and, in some quarters, worries over inflation stoked by easier monetary policy.
- Fiscal 2024 just ended with the government running a budget deficit in excess of $1.8 trillion, including more than $1.1 trillion dedicated solely to paying financing costs on the $36 trillion U.S. debt.
- Neither Trump nor Harris are even discussing fiscal discipline, raising worries that investors will demand higher yields in exchange for holding Treasury paper that suddenly doesn’t look so safe.
In fact, Yardeni sees the fiscal and Fed factors as joint culprits. The central bank is widely expected to approve another quarter percentage point cut when it meets Thursday.
“Investors often hear ‘Don’t fight the Fed,’ but perhaps it’s the Fed that shouldn’t be fighting the Bond Vigilantes,” the head of Yardeni Research said. “The bond market could easily nullify the impacts of another rate cut. That’s because the bond market believes the Fed is cutting rates by too much, too soon, and is therefore raising long-term inflation expectations. These expectations are heightened by concerns about more fiscal excesses from the next administration.”
“Bonds are indicating that the continuation of large fiscal deficits in a Kamala Harris or Donald Trump presidency, and the lack of discipline in monetary policy, warrant a much higher yield,” added Komal Sri-Kumar, president of Sri-Kumar Global Strategies. “The Federal Reserve can ignore the signal at its own peril.”
Harris has been part of an administration in which fiscal largesse, combined with pandemic-related supply and demand factors, led to the highest inflation rate in more than 40 years.
However, it’s Trump’s proposals that have gotten intensified focus lately as online betting sites have raised the odds that he could be elected to another term, despite polls showing a neck-and-neck race.
A study sees trouble
A report from the Peterson Institute for International Economics, a nonpartisan think tank, painted a more dour picture for the nation’s fiscal and economic health as well as for inflation under a Trump presidency.
Author Karen Dynan charged that Trump’s stated intentions to ramp up tariffs and deportations, along with reports that he could seek greater authority over the Federal Reserve, would result “in lower US national income, lower employment, and higher inflation than otherwise.”
“In some cases, economic conditions recover over time, but in others the damage continues through 2040,” the report continued. “And despite Trump’s ‘America first’ rhetoric, these policies would harm the US economy more than any other in the world, particularly trade-exposed sectors such as manufacturing and agriculture. In some cases, other countries would enjoy stronger economic growth than otherwise after receiving inflows of capital leaving the United States.”
The institute has been comparatively quiet about implications for a Harris presidency. A recent working paper said the Democrat’s policies likely would leave baseline forecasts in place because of expected “limited changes to current policies on immigration, trade, and Fed independence.”
Other voices on Wall Street have issued inflationary warnings about Trump’s policies, though in muted tones relative to the Peterson narrative, which estimated potential inflation under Trump as up to 7.4 percentage points above normal in a Trump presidency.
Morgan Stanley, for instance, recently predicted that tariffs and other isolationist policies under Trump could shave 1.4% off real economic growth and raise headline inflation rates by 0.9%.
Similarly, JPMorgan warned that a “red sweep” for Republicans is the “biggest tail risk” from the election. It could carry “higher tariffs and mass deportations, which triggers stagflation in the US including a second inflation spike,” the bank said.
However, the firm also noted that “Trump has shown a willingness to change his views” and the aforementioned “tail risk is not priced-into markets nor is it actively discussed across the US client base.”
Low inflation in Trump’s first term
Indeed, the possibility for tariff-induced inflation spikes was a common criticism of Trump during his first term in office, during which he implemented stringent tariffs. Yet the 12-month inflation rate never eclipsed 3% for even a single month in his presidency — it topped out above 9% during the Biden-Harris administration before receding — while economic growth, save for a severe dip at the Covid onset, held steady throughout.
In fact, some Wall Street analysts think the recent surge in yields will reverse itself as the Fed continues cutting rates and macroeconomic growth settles back to long-term trends in 2025 and beyond.
Evercore ISI sees a possibility for higher inflation under Trump but anticipates it translating into the Fed’s baseline funds rate being just a quarter percentage point higher compared to a Harris presidency. Stocks, meanwhile, performed better under Trump than Biden and Harris, even with the brief Covid-related bear market. Some have tied the recent equity rally to rising odds of a Trump win.
“In our baseline the risk-off effects of trade policy uncertainty and the risk-on effects of Trump animal spirits offset each other,” Evercore said in a client note Monday. To that point, The Conference Board’s monthly sentiment survey for October showed the largest share of respondents in its history, going back to 1987, seeing higher stock prices over the next year.
Over the past few days, meanwhile, yields actually have eased if just a bit, coming off a somewhat counterintuitive surge of about a quarter percentage point, or 25 basis points, following the Fed move. There’s some thought that the decline could in the early stages.
“Although the impact on the bond market from who wins this election won’t entirely go away by this coming Wednesday, it is likely to be far less after the election – regardless of who wins – than it has been with all the uncertainty leading up to this four-year tradition,” market veteran Jim Paulsen recently wrote in his Substack newsletter.
Paulsen coined the term “yield interruptus” for the latest odd moves, which he said “will likely persist for as long as economic momentum continues strengthening. Fortunately, there are a few key indicators suggesting economic momentum is poised to soon moderate perhaps ending the latest interruption.”