Will Trump’s Plans Eclipse the Fed’s Rate Cuts and Jeopardize Bond Recovery?

The Federal Reserve reduced interest rates by 25 basis points during its monetary policy session last Thursday. This followed a significant cut of 50 basis points in September, which initiated the current phase of monetary easing.

However, the likelihood of additional rate reductions is obscured by forecasts that major aspects of Trump’s financial strategy, including tax reductions and tariffs, will drive quicker growth and elevate consumer prices. This scenario could cause the Fed to hesitate in making deep rate cuts next year, tempering hopes that lower borrowing costs might revive bond markets after a prolonged slump.

“The election’s outcome is expected to slow down the pace of rate cuts by the Fed,” commented Tony Rodriguez, Nuveen’s head of fixed income strategy. “We now anticipate fewer rate cuts spread out over a longer period in 2025.”

Since mid-September, Treasury yields have jumped more than 70 basis points and recently recorded their largest monthly increase since the 2008 financial crisis, as reported by UBS Global Wealth Management. This spike aligns with Trump’s rising popularity in polls and betting platforms during October.

Market projections indicated by Fed funds futures now anticipate a decline in interest rates to approximately 3.7% by the end of next year, down from the current range of 4.5%-4.75%. This expectation is around 100 basis points higher than estimates from September.

BofA Global Research strategists have adjusted their short-term forecast for Treasury yields to range between 4.25% and 4.75%, up from the previous 3.5% to 4.25%.

Fed Chair Jerome Powell, speaking on Thursday, opted not to predict how the new U.S. administration might influence monetary policy. He suggested that the recent rise in yields more likely reflects an improved economic forecast rather than increased inflation expectations. September’s consumer price index marked its smallest increase in over three and a half years.

Despite Powell’s views, inflation expectations, as gauged by Treasury Inflation-Protected Securities (TIPS), climbed this week. The 10-year breakeven inflation rate reached 2.4% on Wednesday, its highest in six months.

Dan Ivascyn, PIMCO’s group chief investment officer, expressed concerns about inflation rebounding, potentially causing the Fed to halt or delay rate reductions. “The market might face a tough situation if inflation starts to pick back up,” he noted.

A potential “Red Sweep” scenario, where Republicans could dominate both the presidency and Congress, might simplify Trump’s ability to implement tax cuts and pursue a more aggressive economic agenda.

While the Republicans were poised to secure at least a 52-48 majority in the Senate, the final makeup of the House was still undecided, with vote counting ongoing late into Thursday.

Andrzej Skiba, RBC Global Asset Management’s head of BlueBay U.S. Fixed Income, predicted further sell-offs in long-term bonds. “If tariffs are imposed as we expect, the Fed might be restrained from lowering rates,” he stated.

Rick Rieder, BlackRock’s chief investment officer of global fixed income, wrote that expecting aggressive rate cuts in 2025 might be “overzealous,” viewing bonds more as a source of income rather than a bet on falling rates.

Eye on 4.5%

So far, rising Treasury yields have barely impacted the stock market, which has surged as election uncertainties cleared and investors anticipated stronger economic growth. This optimism pushed the benchmark S&P 500 index to new heights.

Yet, if yields climb too steeply or swiftly, they could pose challenges for equities. Higher yields compete with stocks for investment and increase capital costs for both corporations and consumers.

When the 10-year Treasury yields approached or exceeded 4.5% over the past year, it often led to downturns in the stock market, according to Angelo Kourkafas, a senior investment strategist at Edward Jones. “This could be a critical threshold for market watchers,” he said.

As of late Thursday, the ten-year yields were at 4.34%.

There is also concern that a resurgence of so-called bond vigilantes—investors who sell off government bonds in response to excessive spending—could overly tighten financial conditions, as higher government bond yields increase borrowing costs across the board, from mortgages to credit cards.

Trump’s proposed tax and spending plans could inflate the national debt by $7.75 trillion over the next decade, according to the Committee for a Responsible Federal Budget.

Bill Campbell, a portfolio manager at DoubleLine, voiced concerns about the fiscal health of the country following Trump’s election and anticipated a further increase in long-term yields. “The Red Sweep complicates things,” he remarked.

Inflation expectations rising https://reut.rs/4fCzHdp