Trump may face bond vigilantes amid concerns over inflation and the deficit
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- Rising yields reflect concerns over inflationary policies and potential economic impacts.
- Bond vigilantes may pressure Washington to address deficits, affecting fiscal policy decisions.
- Jimmy Chang says buying right at the 5% tipping point isn't a good idea.
Wall Street doesn't constantly look to Washington for investment advice or direction, but the bond market is one place where they definitely intercept.
As investors increasingly accepted the probability of a Trump victory, the 10-year Treasury entered choppy territory the month heading into elections. The rising yield signaled concerns over inflationary policies under a Republican stronghold.
Markets were discounting an environment in which deregulation and corporate tax cuts could lead to higher investment activity and bigger shareholder returns, stricter immigration laws could cause labor supply shortages, and tariffs and counter-tariffs could pushed up the prices of goods.
While the equities market may be feeling frisky about the prospects of tax cuts, Jimmy Chang, the CIO of the Rockefeller Global Family Office, believes the 10-year yield will be the most important focal point for all investors. All else equal, it drives the relative attractiveness of returns across various asset classes.
But the big question is: how high can the 10-year yield go?
As of Tuesday, it was hovering near 4.4%, but it could surpass the 5% threshold, says Chang, and that's an important marker because it has been the ceiling for the current cycle. The tipping point would create headwinds for the bond market as bond prices drop. But, it could also trigger selling pressure in equities as valuations contract due to higher discount rates. Given the uncertainty around policy impact, there's an elevated degree of risk for buyers of the 10-year and above, Chang noted.
The deficit is another sore spot, as promised tax cuts could further shrink government revenue. He believes that privately, most elected officials and policymakers acknowledge that the structural deficit is a problem that must be addressed, but Washington's electoral cycle is a barrier. Officials don't get reelected by advocating austerity, so, naturally, these issues get pushed down the road, he noted.
"The biggest mission in the last few months was to get reelected," Chang said. "But now that they're reelected, they're in the office, they need to deliver on something more tangible to the market, or they run the risk of getting the so-called bond vigilantes coming back to put pressure on policymaking."
Bond vigilantes, a generic term that represents the collective psyche of investors who may sell or avoid buying bonds as a means of protest against bad fiscal, monetary, or inflationary policies, could cause yields to spike, forcing Washington's hand at addressing the debt sooner. The problem is that it would also drive the government's financing costs up, creating more of a downward spiral.
The incoming administration's policy initiatives will need to instill confidence in the market and demonstrate that they care about controlling deficits to keep tensions at bay, Chang said. And this must be done by showing how they will offset tax cuts and remain fiscally responsible.
"So the psychology is also very important in the market, and this is why it's not a foregone conclusion that we will have a financial crisis," Chang said.
If investors are eyeing the 10-year, he doesn't advise jumping in at the 5% threshold. Once it breaks the ceiling, it's hard to say how high it could go. The buying opportunity is best when there are stabilization signals as policymakers respond to ease tensions.
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