Can Trump Really Challenge the Bond Market?
After rising borrowing costs derailed Bill Clinton's plans in the early 1990s, his political strategist James Carville quipped that if he were reincarnated, he “wanted to come back as the bond market, then you can intimidate everybody.” Three decades later, Carville's words still ring true. Rising bond yields have a unique ability to exert power over politicians, as evidenced by the “mini-budget” crisis triggered by former British Prime Minister Liz Truss, and the ensuing layoffs, policy U-turns, and resignation after borrowing costs soared.
However, there appears to be one world leader who is immune to the threat of the bond market: Donald Trump. Despite the 10-year US Treasury yield rising from 3.8% to 4.2% in the past 12 months, the president has shown no sign of scaling back his ambitions.
A Life-or-Death Battle for Fed Independence
The latest move to unsettle investors is Trump's pledge to fire Federal Reserve governors over mortgage fraud charges, which she herself has denied. This is part of a broader attack by Trump to make the Fed subservient to his will, raising concerns about the central bank's independence.
James Bilson, fixed income strategist at Schroders, believes that the problem is “certainly gaining investors’ attention” and that “we are seeing the market starting to price in a trend towards institutional weakening, i.e. the politicization of the Fed.”
Fears About Inflation and Growth
After Fed Chairman Jerome Powell signaled an imminent rate cut, US Treasury yields fell last weekend. However, Treasury yields have seen sharp fluctuations this week as Trump escalated his feud with Cook.
Investors fear that a “political capture” of the Fed, after Powell's term expires next May, will allow Trump to lower interest rates at the expense of addressing inflationary pressures. Ultimately, this will force the Fed to use higher interest rates to solve the problem in the future.
Former International Monetary Fund (IMF) chief economist Ken Rogoff warned this week that if Trump succeeds in weakening the Fed's independence, the world will face an “incredibly unstable” period.
Political and Economic Risks
David Roberts, head of fixed income at Nedgroup Investments, says investors are “extremely concerned about the politicization of the Fed.” He adds: “Too cheap money will fuel inflation in the future.”
In the lawsuit challenging Trump, Cook's lawyers argue that Trump's power grab at the Fed could cause “irreparable harm” to the central bank for “short-term political gain.”
The gap between two-year and thirty-year US Treasury yields – that is, the difference in borrowing costs for short-term and long-term debt – is now the widest since January 2022, a sign of how concerned investors are about the long-term threat of inflation and the erosion of Fed independence.
Higher long-term borrowing costs carry political risks for Trump. US mortgage rates are typically linked to long-term bonds, as US homebuyers tend to borrow for longer terms compared to the UK or elsewhere. Therefore, higher 10-year and 30-year Treasury yields – that is, the return the government promises to pay to its debt buyers – will quickly hit ordinary people in the United States.
Why Is the Market Calm?
Still, both 10-year and 30-year US Treasury yields remain well below the highs seen in April after Trump’s tariffs. Bilson believes that long-term bond yields are rising in an “orderly” fashion.
Robert Dishner, portfolio manager at Neuberger Berman, says traders were comforted by a recent report from the Congressional Budget Office that Trump’s tariffs had brought in $136 billion in revenue and would reduce the US basic deficit (excluding interest payments) by $3.3 trillion over the next ten years.
Another possible reason the bond market is relatively calm right now is that Trump has shown in the past that he is vulnerable to bond market pressure. When the market crashed after his tariffs, Trump announced a 90-day moratorium.
While relatively calm now, sentiment can change in an instant, and the market's attention will now focus on Cook's legal case. Peter Conti-Brown, professor of financial regulation at the University of Pennsylvania, said in a post: “If Cook wins, she will stay in office and we will achieve a certain degree of stability, and if she loses … that will be the end of the independence that the Fed has built and rebuilt over 112 years.”
In this case, "all hell could break loose". And Trump's determination to confront the bond market may be truly tested.
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