Trump, Tariffs, and Treasury Yields

Lawrence Gillum:

To say last week was a busy week for fixed income markets is an understatement. And there aren't too many things that can overshadow a Federal Reserve meeting, but a presidential election is one such event. So with the presidential uncertainty behind us, in this edition of the LPL Street View, we take a look at what impact a new President Trump administration could have on Treasury yields. The clouds of uncertainty parted last week as former President Donald Trump decisively won the U.S. election, making him the second U.S. president to win non-consecutive terms. Grover Cleveland was the first to do it back in 1892, of course. Investors welcomed the news with renewed risk appetite bidding the S&P 500 to its 50 record high of the year, last Friday. Trump's proposed economic policies including deregulation, a likely extension of the 2017 tax cuts, a possible corporate tax rate cut, and proposed tax exemptions on TIPS, social security, and overtime helped underpin buyer enthusiasm.

Lawrence Gillum:

The immediate de-risking of when the election will be decided was another big factor behind the post-election day rally. But while stocks rallied on the news, the bond market was perhaps a little less enthused, at least initially. Growth expectations rerated higher as the market priced in more economic friendly policy proposals. However, the improving growth outlook was accompanied by concerns over the deficits and rising inflation, especially with Trump's proposed tariff policies. And for the rates market, that could mean broader concerns about a return of inflation and perhaps higher Treasury yields. So for the rates market, despite the recent runup in treasury yields, we think there's still room for yields to move higher for both good and bad reasons. Since the recent lows back on September 16, the 10-year treasury yield is higher by nearly 70 basis points or 0.7%. Markets are forward-looking and tend to adjust based upon expectations.

Lawrence Gillum:

However, given the unpredictable nature of economic data, consensus expectations may be wrong at times, which causes another market adjustment. So after hovering around the lowest level since 2015, the Bloomberg U.S. Economic Surprise Index, which is that light green line, has been trending higher lately, reflecting economic data that has been in general better than expectations. And since Treasury yields have fallen alongside negative economic surprises, it isn't surprising that yields are now moving higher given better economic data and, as a result, fewer Fed rate cut expectations. While that's generally negative for treasury yields, better economic data means the economy still isn't showing signs of slowing. However, and this could be the bad reason, but another reason yields have moved higher is that the bond market isn't fully convinced the inflation genie's back in the bottle. The risk for the bond market is a Fed that cuts too aggressively into a still growing economy, which would then potentially rekindle inflation concerns.

Lawrence Gillum:

Moreover, as it relates to the Trump presidency, there is a concern that deficit spending, which would've likely happened under a Harris presidency as well, and tariffs could help growth but also keep inflation pressures elevated of that recent move higher into the 10-year Treasury yield. Roughly 40% of the move can be attributed to inflation concerns. If yields are gonna go higher, still it could be driven by higher inflation expectations. This is something we're going to continue to watch. So where does that leave us? With the economic data so far continuing to reflect a more resilient economy than originally expected, we think Treasury yields are likely gonna stay in a trading range, at least in the near term. Despite the ongoing discussions about inflation reaccelerating, we think the 10-year Treasury yield could end the year around current levels, but in this new higher-for-longer interest rate environment, income oriented investors have a plethora of opportunities to build portfolios that can generate income levels in excess of 5%. Remember, income has been the largest contributor to returns for fixed income markets, and income remains above longer-term averages. So income opportunities are plentiful. In fact, some might even say we could be in the golden era for income investors. For more on that, be sure to check out our 2025 Outlook set to be released in December. Until next time, thanks for listening.