Key Points and Summary: As Donald Trump prepares to assume office, the bond market is already reacting to fears over his proposed economic policies. Long-term interest rates have spiked, with the 10-year Treasury yield jumping from 3.6% to over 4.7% since his election victory.
-This rise signals concerns about Trump’s planned tariffs and tax cuts, which could exacerbate inflation and balloon the national debt, already nearing 100% of GDP. Experts warn that these policies risk inviting bond market retaliation, increasing borrowing costs, and triggering a recession.
-Trump’s administration may need to reconsider its economic strategy to avoid financial market instability and economic turbulence.
Trump’s Economic Policies Risk Bond Market Rebellion in 2025
James Carville, Bill Clinton’s political adviser, famously said that if reincarnation existed, he wanted to come back as the bond market. He reasoned that you could then intimidate anyone. By this, he meant that the bond market could force governments to change economic policy direction if their policies were not to the bond market’s liking. The bond market could do this by dumping its bond holding, thereby sharply increasing long-term interest rates. Those higher interest rates would be especially painful for anyone who needed a mortgage to buy a home or finance their business activities and they could tip the economy into recession.
A recent example of the bond market disciplining a government occurred in the United Kingdom in 2022 when the then prime minister Liz Truss presented a budget that the market considered putting the country on a dangerous debt path. In response, the gilt market and the pound sterling plummeted, pushing the economy closer to a recession.
The net result was that Liz Truss was forced to resign as prime minister, and her replacement, Rishi Sunak, was forced to make a humiliating budget U-turn.
All of this would be particularly relevant for the incoming Trump administration. At a time when the Federal Reserve is trying to get interest rates lower to support the economy, the bond market is sending long-term interest rates higher out of fear of what the incoming administration’s economic policies might be.
So, we now have the unusual situation where the Fed is cutting its interest rat,e but long-term interest rates are moving sharply higher.
Since it became clear to the bond markets that Donald Trump would win the election, the 10-year Treasury bond yield has spiked by more than 100 basis points from around 3.6 percent to over 4.7 percent.
The bond market seems to be anticipating that the incoming Trump Administration’s policy will cause inflation to rise. This fear would not appear to be irrational considering the economic promises that President-elect Trump made on the campaign trail. According to Goldman Sachs, the 60 percent tariff Trump proposes to impose on all imports from China and the 10-20 percent tariff he proposes to impose on the rest of our trade partners would add one percentage point to inflation.
More serious yet, the tax cuts Trump plans to enact will cause the budget deficit to rise from its already troubling 6 ½ percent of GDP. It would thereby risk a return of inflation by increasing aggregate demand when the economy was already close to capacity.
With the public debt already at around 100 percent of GDP, the country’s last need is continued budget deficits. According to the Committee for a Responsible Budget, over the next decade, the Trump tax cuts would add around $7 ¾ trillion to the national debt, and by 2034, that debt would exceed 140 percent of GDP.
This could raise serious questions about our public debt’s sustainability and invite the bond vigilantes’ return. It could also cause foreign debt holders to put further pressure on our long-term interest rates by offloading their extensive Treasury bond holdings.
A spike in long-term interest rates has to raise the risk of recession. Mortgage rates are already at multi-year highs, making home ownership ever less affordable. Meanwhile, the commercial property sector is in deep trouble as a result of changed work habits following the pandemic, and corporate bankruptcies are at their highest levels since 2010. Against that background, a further rise in the 10-year government bond yield could cause something in the financial system to break and is the last thing we need right now.
We must hope the incoming Trump administration will substantially dial back Mr. Trump’s campaign promises of punitive import tariffs. If not, we should brace ourselves for some rough sledding in the US economy and financial markets.
About the Author: Desmond Lachman
American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.
