Financial markets usually do not begin to assess the likely outcome of an election until a month or two before Election Day. Investors have an early start this year.
Since June 27, the interest rate on 10-year Treasury notes has increased by about 10 basis points, or one-tenth of a percentage point. That may not sound like much, but it is a reversal of the bearish trend that has taken place in recent weeks as inflation data has come in very soft and fueled hopes of a rate cut.
Around June 27, something seems to have changed investors’ interest rate outlook. Hmm, what could it have been? Oh okay! June 27 was the date of the first presidential debate between President Joe Biden and former President Donald Trump, during which Biden bombed and even seemed incoherent at times.
Biden’s performance was so disturbing that it quickly changed the outlook of the election. Trump’s chances of winning increased, but more importantly for the markets, the chances of Trump winning and Republicans gaining control of both houses of Congress also increased. Markets care about this because a president cannot implement his full agenda if a friendly Congress is unable to pass the legislation he supports.
“This is about bond investors starting to appreciate the possibility that not only does Donald Trump emerge victorious, but that the GOP also takes the House and Senate,” economist David Rosenberg of Rosenberg Research wrote in a July 3 analysis. “Investors are smelling something here, which is GOP control of Congress.”
As a real estate developer who once called himself the “king of debt,” Trump favors the lowest possible rates. But Wall Street thinks Trump’s policies in a second term would be more likely to push rates up rather than down.
Read more: How much control does the president have over the Fed and interest rates?
There are several reasons for this. First, Trump wants to impose new tariffs on imports that would raise prices on thousands of everyday items, which is essentially inflationary. That would come at a time when built-in inflationary pressures, such as tight global energy markets and shipping disruptions in the Red Sea, are much stronger than when Trump was president from 2017 to 2021.
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In 2022, the Federal Reserve began rapidly raising short-term rates to combat inflation that peaked at 9% that year. The Fed stopped raising rates last summer and inflation is now 3.3%. The latest data suggests that if nothing changes, inflation should continue to fall and the Fed may be able to begin gradually cutting interest rates by the fall, which would benefit home and car buyers and many borrowers. others.
But Trumpflation, if it develops, could halt those rate cuts. The Fed could push for a rate cut even with the prospect that Trump could win in November — especially if markets are signaling that this is the expected outcome. And if Trumpflation did indeed materialize, the Fed might have to raise rates instead of cutting 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. Such moves would force the Treasury to borrow far more than currently projected, even pushing federal deficits to record highs.
There have already been some worrisome bumps in Treasury auctions in recent months due to the sheer volume of federal debt in the market. Issuing even more could trigger the debt crisis that many analysts have been expecting for years. This will happen if/when there aren’t enough buyers for all the debt Uncle Sam is issuing, which will force rates to rise to attract buyers. When Treasury rates rise, all borrowing rates rise together.
The latest rise in the 10-year rate after the June 27 debate was even stronger until Fed Chairman Jerome Powell made upbeat comments about the inflation outlook on July 2. That pushed long-term rates down slightly and reignited hopes for a rate cut in September.
But there is still a Trump premium on tariffs. The overall advance before Powell spoke was about 20 basis points, or two-tenths of a point. So it’s fair to assume that markets are, for now, pushing long-term rates two-tenths of a point higher than they would otherwise be based on the chances of a Republican sweep.
If Trump were to win and rates rise as investors seem to expect, that would likely put Trump on a wartime footing from Day One. Trump has a long history of attacking the Fed and its chairman, Powell, for not cutting rates. During Trump’s first term, he could argue that there was little risk of inflation, so why not cut rates?
Inflationary pressures are much stronger now, and that won’t change if Biden leaves office, since most of the pressure comes from outside the United States. If Trump were to get the Fed to cut rates anyway, the result would most likely be higher inflation — and the same anger from voters that has driven Biden’s popularity underwater. Voters may not see this until 2025, but it’s already a big blip on the market’s radar.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjewman.
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