Financial markets typically don’t start pricing in potential election outcomes until a month or two before election day. Investors are getting in early this year.
Since June 27, the yield on 10-year Treasury securities has risen 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 downward trend that has been underway in recent weeks as inflation data has been very mild and hopes for rate cuts have been stoked.
Around June 27, something seems to have changed in investors’ interest rate outlooks. Hmm, what could it have been? Oh yeah! June 27 was the date of the first presidential debate between President Joe Biden and former President Donald Trump, in which Biden flopped and at times even appeared incoherent.
Biden’s performance was so unsettling that it quickly changed the outlook for the election. Trump’s chances of winning rose, but more importantly for markets, the odds of Trump winning and Republicans taking control of both houses of Congress also rose. Markets care about that because a president can’t implement his full agenda unless a friendly Congress can pass the legislation he supports.
“This is all about bond investors starting to price in not just Donald Trump, but the GOP taking control of the House and Senate,” wrote economist David Rosenberg of Rosenberg Research in a July 3 analysis. “Investors smell something here: GOP control of Congress.”
A real estate developer who once called himself the “king of debt,” Trump favors the lowest possible rates. But Wall Street believes Trump’s policies will push rates up rather than down in a second term.
Read more: How much control does the president have over the Fed and interest rates?
There are a couple of reasons for this. First, Trump wants to impose new tariffs on imports, which would raise the prices of thousands of everyday items, effectively inflationary. This 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 they were when Trump was president from 2017 to 2021.
Send Rick Newman a message, follow him on twitteror sign up for his newsletter.
In 2022, the Federal Reserve began rapidly raising short-term interest rates to combat inflation, which peaked at 9% that year. The Fed stopped raising rates last summer, and inflation is now running at 3.3%. Recent data suggests that if nothing changes, inflation should continue to fall and the Fed may be able to gradually cut interest rates by the fall, which would benefit home and car buyers and many other borrowers.
But Trumpflation, if it develops, could put an end to those rate cuts. The Fed could delay rate cuts even in the face of a possible Trump victory in November — especially if markets indicate that that is the expected outcome. And if Trumpflation were to materialize, the Fed might have to raise rates instead of cutting them.
Trump also wants to cut corporate taxes by another percentage point and extend the personal tax cuts that expire in 2025. Such moves would force the Treasury Department to borrow far more than current projections, further widening record-high federal deficits.
There have been some troubling blips in Treasury auctions in recent months due to the sheer amount of federal debt on the market. Issuing even more could trigger the debt crisis that many analysts have been expecting for years. That will happen if/when there aren’t enough buyers for all the debt that Uncle Sam is issuing, forcing interest rates higher to attract buyers. When Treasury rates rise, all borrowing rates rise together.
The recent rise in the 10-year yield after the June 27 debate was even more dire until Fed Chairman Jerome Powell made optimistic comments on the inflation outlook on July 2, pushing long-term rates slightly lower and reviving hopes for a rate cut in September.
But there is still a Trump premium on interest rates. The total increase before Powell spoke was about 20 basis points, or two-tenths of a point. So it is reasonable to think that markets, for now, are pushing long-term rates two-tenths of a point higher than they would otherwise be based on the probability of a Republican victory.
If Trump were to win and rates rose as investors seem to expect, that would likely put Trump on the warpath from day one. Trump has a long history of bashing 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 they won’t change once Biden leaves office, since much of the pressure is coming from outside the United States. If Trump does manage to force the Fed to cut rates, the result would likely be higher inflation — and the same voter anger that has driven Biden’s popularity underwater. Voters may not see that until 2025, but it’s already a big blip on the market’s radar.
Rick Newman is a senior columnist for Yahoo FinanceFollow him on Twitter at @rickjnewman.
Click here for political news on business and financial policies that will determine tomorrow’s stock prices.
Read the latest financial and business news from Yahoo Finance
