Analysis-Bond rebound uncertain as Trump plans overshadow Fed rate cuts
2024.11.08 00:59
By Davide Barbuscia and Lewis (JO:) Krauskopf
NEW YORK (Reuters) – Prospects of a near-term rebound in the $28-trillion U.S. government bond market are faltering, as Donald Trump’s return to the White House is expected to usher in fiscally expansive policies that could temper the extent of the Federal Reserve’s future rate cuts.
The Fed lowered rates by 25 basis points at its monetary policy meeting on Thursday, following a jumbo-sized, 50 basis point reduction that kicked off its current easing cycle in September.
But the outlook for further rate cuts has been clouded by expectations that key elements of Trump’s economic platform such as tax cuts and tariffs will lead to faster growth and higher consumer prices. That could make the Fed wary of risking an inflationary rebound by cutting rates too deeply next year, denting expectations that falling borrowing costs could spur a rebound in bonds after a weekslong selloff.
“One of the major impacts (of the election), we think, will be to cause the Fed to lower rates more gradually than would have been the case,” said Tony Rodriguez, head of fixed income strategy at Nuveen. “Expected cuts in 2025 we now think will be fewer and further apart.”
Treasury yields – which move inversely to government bond prices and tend to follow interest rate expectations – have surged by over 70 basis points since mid-September and recently notched their biggest one-month rise since the 2008 global financial crisis, according to UBS Global Wealth Management. The move coincided with Trump’s improving standing in polls and betting markets throughout October.
Fed funds futures show investors are now expecting rates to decline to about 3.7% by the end of next year from the current 4.5%-4.75% range. That is about 100 basis points higher than what was priced in September.
Strategists at BofA Global Research recently shifted their near-term target for Treasury yields to the 4.25% to 4.75% range, from 3.5% to 4.25% previously.
Fed Chair Jerome Powell on Thursday declined to speculate on the impact the new U.S. administration will have on monetary policy. He said higher yields were likely more reflective of an improved economic outlook rather than higher inflation expectations. Consumer prices notched their smallest rise in more than 3-1/2 years in September.
Still, inflation expectations as measured by Treasury Inflation-Protected Securities (TIPS) surged this week, with the 10-year breakeven inflation rate rising to 2.4% on Wednesday, its highest in over six months.
Dan Ivascyn, group chief investment officer at bond giant PIMCO, said he was worried about rebounding inflation forcing the Fed to slow or pause rate cuts.
“I think the pain trade for the market over the short term would be a situation where inflation begins to re-accelerate,” he said.
A so-called Red Sweep scenario in which Republicans control the White House and both houses of Congress could make it easier for Trump to enact tax cuts and give Republicans more leeway for their economic agenda.
While Republicans were set to hold a majority of at least 52-48 in the U.S. Senate, final control of the lower chamber was yet unclear, with vote counting still underway late Thursday.
Andrzej Skiba, head of BlueBay U.S. Fixed Income at RBC Global Asset Management, said he was bracing for long-term bonds to sell off further.
“If tariffs are rolled out to the extent that we believe they will, that could prevent the Fed from cutting rates,” he said.
Rick Rieder, BlackRock’s chief investment officer of global fixed income, wrote on Thursday that it would be “overzealous” to assume aggressive rate cuts in 2025, and said bonds were more attractive as an income-generating asset than a play on falling rates.
WATCHING 4.5%
Rising Treasury yields have so far had little effect on the stock market, which has shot higher as the uncertainty over the election cleared and investors positioned for the possibility of stronger economic growth, pushing the benchmark to a record high.
But yields could cause trouble for stocks if they rise too far or too quickly. Higher yields offer investment competition for equities while raising the cost of capital for companies and consumers.
When 10-year Treasury yields neared 4.5% or went higher over the last year, “it has triggered some pullbacks in equity markets,” said Angelo Kourkafas, senior investment strategist at Edward Jones. “That could be a level that people are looking at.”
Ten-year yields stood at 4.34% late on Thursday.
Others feared a return of so-called bond vigilantes – investors who punish profligate governments by selling their bonds – could tighten financial conditions excessively, as higher government bond yields push up borrowing costs for everything from mortgages to credit cards.
Trump’s tax and spending plans could increase the debt by $7.75 trillion over the next decade, according to a recent estimate from the Committee for a Responsible Federal Budget.
Bill Campbell, portfolio manager at DoubleLine, said he was worried about the fiscal profile of the country after Trump’s election and was betting on a further rise in long-term yields.
“The Red Sweep complicates things,” he said.
