There is an invisible glue that binds the economy. It determines the cost of your day-to-day life, such as your mortgage, credit card bills and business loans. You might not know it’s there, but you’ll sorely miss it if it ever goes away.
The $27 trillion U.S. Treasury market, the largest government bond market in the world by multiples, is the starting point for the cost of capital. It directly affects the everyday activities of American consumers and businesses. It helps determine how much the government can spend and underpins global American power.
Policy proposals from Donald Trump and his circle threaten the huge advantages the United States enjoys from this market. These include unfunded tax cuts, an even broader trade war, a weakening of the dollar and a reduction in the independence of the Federal Reserve. Taken alone, they would likely raise borrowing costs for businesses, households and the government. That means everyone would have less money to spend.
We know campaign promises do not always become reality. Both parties have implemented policies over time that have had costs as large as their benefits. Still, the potential fallout from this particular set of ideas would be a significant disruption to the Treasury market and everything that depends on it, including interest rates. Republicans must find other ways to achieve their economic goals.
Consider the G.O.P. plan to extend the 2017 tax cuts. If not offset with new revenue or reduced spending, these cuts would worsen an already daunting fiscal position. The Congressional Budget Office estimated in May that extending these tax cuts would add $4.6 trillion to the government deficit over the next decade. That can be covered by selling more Treasury debt, but only up to a point. If investors don’t want the additional bonds, prices will fall and the related interest payout will have to rise to keep them attractive. That’s one mechanism by which borrowing gets more expensive.
A similar dynamic would be at play in a trade war. Tariffs tend to raise prices for the goods that are targeted — they are essentially a tax on imports that gets passed on to consumers or companies. Depending on their scale and impact, the central bank might need to keep interest rates higher for longer to tamp tariffs’ inflationary effect.
Worse would be countries reducing their dependence on dollar-based financial markets. We would likely see such a shift through a change in central banks’ foreign reserve holdings, nearly 60 percent of which are held in dollar-based assets today, of which about half are U.S. Treasury bonds. About one-third of all U.S. government debt is owned by overseas investors, with China the second-largest holder after Japan. If these countries start selling, it will be increasingly hard to finance the deficit. Even simply buying less would put the pressure on.
Mr. Trump’s former trade representative Robert Lighthizer has suggested that along with tariffs, America should consider steps that would weaken the dollar to support exporters and reduce the trade deficit. Senator JD Vance, Mr. Trump’s running mate, seems to agree: While noting the benefits of a globally dominant currency last year during a hearing with the Federal Reserve chairman, Jerome Powell, Mr. Vance described a strong dollar as a “massive tax on producers.” A weaker currency would also add to inflation and pressure on the Fed to keep rates higher.
As with tariffs, the bigger risk is structural. A weaker dollar would reduce returns on U.S. bonds held by foreign investors, making them relatively less attractive, while greater uncertainty around U.S. currency policy could similarly hurt Treasuries and U.S. assets broadly.
Mr. Trump, in office and since, has harangued Mr. Powell (a Trump appointee) about interest rate policy. Recent reporting suggests that if re-elected Mr. Trump might push to reduce the Fed’s independence, something some of Mr. Trump’s advisers have denied. Since Paul Volcker took the helm in the late 1970s, Fed chairs have fiercely protected their independence to make their decisions more credible to markets and thus more effective.
It’s possible Treasuries won’t be threatened by these sorts of maneuvers given that the United States is a unique safe haven for global investors. There aren’t any similarly easy-to-transact government bonds anywhere else. If you don’t like U.S. government policy, you are still likely to hold the country’s debt.
You’d hope a second Trump administration would not want the Fed to step away from ensuring a smoothly functioning Treasury market, given that such a scenario could easily put the economy at risk. The Fed has regularly intervened during times of stress, as was the case in March 2020, to ensure financial market stability.
That said, the mere chance of a meddling political hand can rattle markets. The latest Mexican election illustrates the point. The greater-than-expected voter support for the ruling party triggered a rapid market sell-off. That was in part because investors worried the government might implement campaign pledges to reduce power for the judiciary and some regulatory agencies. The Mexican peso saw its biggest weekly drop since the start of the pandemic. Local equity prices also fell.
In France, President Emmanuel Macron’s unexpected call for elections this summer triggered a sharp selling of stocks and bonds, as well as a warning from Moody’s ratings agency that it could downgrade France’s sovereign debt. The concern? Potential political instability as far-left and far-right parties with looser fiscal policies appeared more likely to take control of the government. (While they did gain seats in the legislature, the final results were not as extreme as many feared.) Similarly, in September 2022, Britain’s short-lived Prime Minister Liz Truss proposed increasing spending and substantially cutting taxes on top of an already large budget. Days after the pound dropped to a record low against the dollar, the government was forced to withdraw its proposals and the central bank had to intervene to stabilize markets. Weeks later, the Truss government collapsed.
America has an underappreciated treasure in its Treasury market. Its depth and credibility provide an important global policy lever. Strong demand for U.S. bonds from overseas and at home reduces borrowing costs for consumers and businesses, and has allowed the U.S. government for years to live beyond its means at minimal cost. The pressures on it are mounting. Let’s not add more to the list.