Bond Markets Prepare for Deficits with Trump or Biden

One likely outcome of the lack of budget restraint from either Biden or Trump is a higher frequency of ‘pretty weak’ Treasury auctions, a strategist says.

A key takeaway from Thursday night’s debate between President Joe Biden and his Republican challenger Donald Trump is that the U.S. faces little prospect of fiscal restraint, regardless of who wins the Nov. 5 election.

Both Biden and Trump are likely to extend parts or all of the 2017 Trump tax cuts, which include provisions for households set to expire at the end of 2025. Biden intends to extend these for individuals making under $400,000, while Trump aims for a full extension.

However, their ability to implement these policies will depend on their control over Congress. The Congressional Budget Office estimates that extending the Trump tax cuts for the next decade would add about $4.6 trillion to the deficit, which is currently around $1.2 trillion with the government two-thirds through its fiscal year.

On Friday, U.S. government debt sold off, pushing yields on 10-year notes and 30-year bond to their highest closing levels in over two weeks.

Trump or Biden

“There’s a slim chance of fiscal restraint as both candidates aim to renew parts of the Tax Cuts and Jobs Act,” said Will Compernolle, a macro strategist at FHN Financial in New York. “I’m unsure where the political will to narrow the deficit will come from,” he added, noting that even a divided government that causes gridlock tends to maintain the status quo, which is a widening deficit.

A lack of fiscal restraint usually leads to more issuance of U.S. government debt, raising concerns about the $27 trillion Treasury market and the potential for waning investor appetite leading to broader disruptions.

Compernolle suggests, “We might see more frequent weak auctions, indicating low demand for higher supply. However, this will likely happen incrementally rather than as major disruptions.”

Treasury auctions are a primary method for traders and investors to express their views on the growing government debt. Parts of Wall Street have been unsettled by the possibility that investors’ appetite for this debt might be limited. For instance, a poorly received 30-year auction in November briefly sent the corresponding Treasury yield up significantly and marked a period where weak demand at debt sales negatively impacted stocks. Similar shaky auction results were observed last month.

BMO Capital Markets strategists Ian Lyngen and Vail Hartman point out two main risks for the Treasury market. One is a resurgence of inflation, pushing interest-rate expectations into 2025. The other risk is a sweep by either party in the election, allowing greater deficit spending without fiscal checks.

“A split control between the White House and Congress would limit further deficit growth, although it could bring the debt ceiling debate back into focus,” Lyngen and Hartman wrote in a note this week.

Earlier this month, the Congressional Budget Office updated its projections, expecting the federal budget deficit to reach $1.9 trillion in fiscal 2024, or $2 trillion with certain adjustments, and federal debt held by the public to reach 122% of GDP by 2034.

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