Financial markets typically don't start pricing in the outcome of an election until a month or two before Election Day, and investors have been getting in early this year.
Since June 27, interest rates on 10-year Treasury notes have risen by about 10 basis points, or 0.1 percentage points. While this may not seem like much, it reversed a downward trend that had taken hold in recent weeks as very mild inflation measures raised expectations of interest rate cuts.
Something appears to have changed investors' interest rate outlook around June 27th. Hmm, what was it? Ah, that's right! June 27th was the day of the first presidential debate between President Joe Biden and former President Donald Trump, during which Biden stumbled and at times appeared unable to deliver a coherent speech.
Biden's performance was so unsettling that it quickly changed the outlook for the election. It made Trump's victory more likely, but what's more important for the markets is that it also made it more likely that Trump would win and that the Republicans would have majorities in both houses of Congress. The reason the markets care about that is that the president can't fully implement his policies unless he can pass legislation supported by a friendly Congress.
“This is all because bond investors are starting to price in the possibility that not only will Donald Trump win, but Republicans will also take control of the House and the Senate,” David Rosenberg, an economist at Rosenberg Research, wrote in an analysis on July 3. “Investors are sniffing something here: Republicans taking control of Congress.”
A real estate developer who once called himself the “Debt King,” Trump favors the lowest possible interest rates, but Wall Street believes his policies in a second term are more likely to raise interest rates than lower them.
Read more: How much control does the president have over the Fed and interest rates?
Will they go up? Wall Street believes President Trump's second term policies are more likely to raise interest rates than lower them. (Photo by Clive Mason/Getty Images) (Clive Mason via Getty Images)
There are several reasons. First, President Trump is seeking to impose new tariffs on imports that will raise the prices of thousands of everyday products, essentially creating inflation. This comes at a time when underlying inflationary pressures, such as tight global energy markets and disruptions to maritime shipping in the Red Sea, are much stronger than they were during Trump's presidency from 2017 to 2021.
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In 2022, the Federal Reserve began rapidly raising short-term interest rates to combat inflation that peaked at 9% that year. The Fed stopped raising interest rates last summer, and inflation is currently at 3.3%. Recent data suggests that if nothing changes, inflation will continue to fall and the Fed may be able to begin gradually lowering interest rates by the fall, benefiting home and car buyers and many other borrowers.
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But a Trumpflation event could put a stop to those cuts. Even if Trump wins in November, the Fed could hold off on cutting rates, especially if markets suggest that's the expected outcome. And if Trumpflation does materialize, the Fed may be forced to raise rates instead of lower them.
President Trump also wants to cut the corporate tax rate by another 1 percentage point and extend personal tax cuts that are set to expire at the end of 2025. Such measures would force the Treasury Department to borrow much more than currently projected, further increasing the federal budget deficit, which is already at a record high.
There have already been some disturbing fluctuations in Treasury auctions in recent months due to the sheer amount of federal debt circulating on the market. Any more issuance could trigger a debt crisis that many analysts have predicted for years. This means that if there are not enough buyers for all the debt the U.S. government issues, interest rates will rise to attract buyers. When Treasury interest rates rise, all borrowing rates rise in tandem.
The recent rise in 10-year Treasury yields following the June 27 debate was even more pronounced until Fed Chairman Jerome Powell made optimistic comments about the inflation outlook on July 2, which pushed longer-term interest rates down slightly and rekindled hopes of a rate cut in September.
But there is still a Trump premium in interest rates: Rate increases before Powell's comments totaled about 20 basis points, or 0.2 percentage points, so for now it's safe to assume the market is pushing long-term rates 0.2 percentage points higher than normal based on the probability of a Republican sweep.
If Trump wins and interest rates rise as investors expect, he will likely be on a war footing from day one. Trump has long criticized the Fed and its Chairman, Powell, for not lowering interest rates. He could argue that there is little risk of inflation in his first term, so why not lower interest rates?
Inflationary pressures are now much stronger, and much of it coming from outside the U.S., so Biden leaving office likely won't change that. Even if Trump were to verbally pressure the Fed to cut interest rates, the result would likely be higher inflation, incurring the ire of the same voters who caused Biden's approval rating to plummet. Voters may not feel it until 2025, but it's already a big sign on the market's radar.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter. Follow.
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