As the election wrapped up, concerns about ‘bond vigilantes’ and inflation hit the markets.

The potential for Donald Trump to win the presidential election has contributed to sentiment in financial markets that the firebrand candidate’s policies could stimulate both economic growth and inflation.

If Donald Trump defeats Kamala Harris, some see a scenario in which rising budget deficits along with a potential global trade war could mean rising inflation, soaring bond yields and rising stock markets.

This would be bad for the value of the underlying bond since yields and prices move in opposite directions. Depending on how things progress, there’s even talk of “bond vigilantes” reemerging. These are traders who essentially force the government’s hand by canceling government debt or selling government debt outright.

Investor Ed Yardeni coined the term in the 1980s and warned that vigilantes could return. In particular, he said traders 10-year government bond yieldIt surpassed the bond market benchmark of 5%, a level not seen since mid-2007.

“We are not yet demanding that the 10-year Treasury yield reach 5%, but bond vigilantes appear to be threatening to get there,” Yardeni wrote in comments Monday.

There are certainly a number of reasons why bond markets have been in turmoil since mid-September, and political considerations about a second Trump term are just one of them. consider:

• The Federal Reserve cut its benchmark short-term borrowing rate by 0.5 percentage points on September 18. While this would generally have pushed the rest of the yield structure lower, it has instead sparked expectations of stronger economic growth and, in some quarters, easing monetary policy, sparking inflation concerns.
• Fiscal year 2024 just ended with the government running a budget deficit of more than $1.8 trillion, including more than $1.1 trillion invested just to pay for financing the $36 trillion in U.S. debt.
• Neither Trump nor Harris are even discussing fiscal discipline, raising concerns that investors will demand higher yields in return for holding Treasury bonds that suddenly don’t seem very safe.

In fact, Yardeni sees fiscal and Fed factors as common causes. The central bank is widely expected to approve another quarter-percentage point cut at its meeting on Thursday.

“Investors are often told, ‘Don’t fight the Fed,’ but perhaps the Fed shouldn’t be fighting bond vigilantes,” said Yardeni Research, principal. “The bond market could easily nullify the impact of another rate cut because they believe the Fed is raising long-term inflation expectations by cutting rates too much and too quickly. These expectations could lead to more rate cuts. It will increase due to fiscal excess from the next government.”

Komal Sri-Kumar, president of Sri-Kumar Global Strategies, added, “Bonds indicate that the continuation of large fiscal deficits and lack of discipline in monetary policy under Presidents Kamala Harris or Donald Trump warrants much higher yields.” . “The Fed could ignore this signal at its own peril.”

Harris was part of an administration whose fiscal stimulus combined with pandemic-related supply and demand factors led to the highest inflation rate in more than 40 years.

But Trump’s proposals have come into more focus recently as his chances of winning another term increase, even though online betting sites show a close race in the polls.

A report from the Peterson Institute for International Economics, a nonpartisan think tank, paints an even bleaker picture of the country’s fiscal and economic health and inflation during Trump’s presidency.

Author Karen Dynan said President Trump has announced his intention to increase tariffs and deportations, and there have been reports that he may seek greater authority over the Federal Reserve, adding, “American national income is lower than it would otherwise be.” “Employment will fall and inflation will rise,” he criticized.

“In some cases, economic conditions will recover over time, but in others, the damage will continue until 2040,” the report added. “And despite Trump’s ‘America First’ rhetoric, these policies will do more harm to the U.S. economy, especially trade-exposed sectors such as manufacturing and agriculture, than to any other country in the world. In some cases, more than other countries have done since. We could also enjoy strong economic growth, with capital flowing out of the United States.”

The institute has been relatively quiet about the impact on Harris’ presidency. Democrats’ policies will likely remain in line with their baseline projections, as a recent research report predicts “limited changes to current policies on immigration, trade, and Federal Reserve independence.”

Other voices on Wall Street have issued inflationary warnings about Trump’s policies, but in a more subdued tone compared to Peterson’s narrative, estimating potential inflation under Trump’s presidency could be up to 7.4 percentage points higher than usual.

For example, Morgan Stanley recently predicted that President Trump’s tariffs and other isolationist policies could reduce real economic growth by 1.4% and increase the inflation rate by 0.9%.

Likewise, JPMorgan warned that a “red sweep” for Republicans was the “biggest tail risk” of this election. “This could result in higher tariffs and mass deportations that could trigger stagflation in the United States, including a second surge in inflation,” the bank said.

However, the company also noted that “President Trump has demonstrated a willingness to change his views” and pointed out that the aforementioned “tail risks are not reflected in the markets nor are they actively discussed across our U.S. customer base.”

In fact, the possibility of a surge in inflation due to tariffs was a common criticism during President Trump’s first term in office when he imposed strict tariffs. However, the 12-month inflation rate never exceeded 3% for a single month during the president’s term. It rose above 9% during the Biden-Harris administration and then withdrew. Steady throughout.

In fact, some Wall Street analysts think the recent surge in yields will reverse itself as the Federal Reserve continues to cut interest rates and macroeconomic growth returns to its long-term trend after 2025.

Evercore ISI sees the potential for higher inflation under Trump, but expects this to result in the Fed’s benchmark interest rates only being a quarter of a percentage point higher than under a Harris presidency. Meanwhile, stocks performed better under Trump than Biden and Harris despite a brief Covid-related bear market. Some have linked the recent rise in stocks to increased odds of Trump winning.

“At baseline, the hedging effect of trade policy uncertainty and the hedging effect of the Trump animal spirit cancel each other out,” Evercore said in a client note Monday. To that point, the Conference Board’s October Monthly Sentiment Survey, dating back to 1987, showed the highest percentage of respondents in history expecting stocks to rise higher in the coming year.

Meanwhile, yields have actually eased slightly following the Fed’s actions over the past few days, with a somewhat counterintuitive jump of about a quarter of a percentage point, or 25 basis points. There is also the idea that it may decline in the early stages.

“Depending on who wins this election, the impact on bond markets will not be completely gone by Wednesday, but the impact of all the uncertainty is likely to be much smaller after the election, regardless of who wins. Continuing a four-year tradition. ” Market veteran Jim Paulsen recently wrote in his Substack newsletter:

Paulsen coined the term “yield break” for the recent strange moves. He said: “As long as economic momentum continues to strengthen, it is likely to continue. Fortunately, there are several key indicators that suggest economic momentum may be poised to ease soon.”