Both Vice President Kamala Harris and former President Donald Trump want to increase spending and cut taxes in ways that could cost the government trillions of dollars over the next ten years. However, if the bond market doesn’t agree, none of those plans will work out.
Recent economic data, like the consumer price index report released on Thursday, show that inflation is still well above the Federal Reserve’s 2% goal.
Treasury bond prices have gone up because of this, even though the Fed cut rates by a big 50 basis points in September and plans to do more by the end of the year.
It is the Fed’s goal to keep rates low so that the jobless rate doesn’t go up and send the U.S. economy into deep recession.
FactSet says that the yield on the 10-year Treasury note TMUBMUSD10Y 4.083% has gone up by almost 50 basis points in the last month.
This week, expert Ed Yardeni wrote, “Now that the Fed is less worried about inflation, we think it is important to be more careful.” “It’s possible that our friends the Bond Vigilantes just woke up.”
In the 1980s, Yardeni came up with the word “bond vigilantes” to describe traders who buy and sell government bonds and raise interest rates to force governments to either cut deficits or raise interest rates.
He said that the difference over the last month between the 10-year Treasury bond and the 10-year inflation-protected Treasury bond has grown a lot. This difference shows where the market thinks inflation is going.
Yardeni also said that war in the Middle East could cause oil prices to rise, which could make inflation worse in the coming months.
The whole economy is affected by the rise in government bond yields, which makes it more expensive for people and companies to borrow money.
If inflation stays high and bond rates rise, it might be hard for the next president, whether it’s Trump or Harris, to add to the budget gap with tax cuts or spending plans.
Economists think that bigger budget deficits cause inflation by making more people want to buy goods and services. They also think that these deficits may cause borrowing costs to go up because bond buyers are afraid that spending too much will cause inflation and make their investments less valuable.
In 1993, President Bill Clinton learned this the hard way when his famous political advisor James Carville said that he would like to come back as the bond market because “you can scare everyone.”
Clinton was elected in January of that year on a wave of dissatisfaction with the status quo. The Republican Party had been in charge of the White House for 12 years and had promised to cut taxes for the middle class while also cutting the deficit through cuts to defense spending and higher taxes on the rich.
But in the years before the 1992 election, the government budget deficit was growing. That year, it reached a record high of $290 billion. Even though the Fed had been steadily lowering rates for years, the cost of getting money stayed stubbornly high.
According to FactSet, the yield on the 10-year Treasury bond went up by 50 basis points from September 1992 to over 7% in the weeks after the election. This made Clinton’s economic adviser Robert Rubin even more determined to stick to his plan to cut the deficit quickly by giving up on plans for tax cuts for the middle class and stimulus investments.
“What we do here will send a signal of how serious we are about fighting the deficit,” Rubin said at a meeting in the White House in 1993. The New York Times wrote about the meeting that year. “This is the goal we set, and we need to stick to it to keep the financial markets’ trust.”
The budget deal that was passed in August 1993 cost the president and his congressional friends a lot of political support. However, it set the stage for an economic boom and a balanced budget in the second half of the decade.
Before the full effects of the law hit in 1994, bond yields kept going up and prices kept going down. This was known as “The Great Bond Massacre.” But after that, yields and budget deficits started going down for a few years.
In 1998, when the government had its first budget balance since 1969, the yield on the 10-year Treasury fell below 5%.
After Trump’s tax cuts, which would cost the government more than $8.5 trillion over 10 years, and Harris’s policies, which would also cost several trillions, bond markets might rise up again, just like they did 30 years ago.
Brian Rehling, who is in charge of global fixed-income strategy at Wells Fargo, recently sent a note to clients saying that people and businesses should get ready for higher debt loads, which will make it more expensive to borrow money, and for private investment to be stifled, which will slow down the economy and lower incomes.
“Even if there isn’t going to be a crisis soon,” he wrote, “the effects of a big national debt are likely to be real and significant.”
