"The New Bond King" makes a strong statement: If the Republicans achieve a "red wave," U.S. Treasury yields may rise even higher

According to the Zhitong Finance APP, Jeffrey Gundlach, the CEO of DoubleLine Capital, known as the "new bond king," stated on Thursday Eastern Time that if the Republican Party ultimately gains control of the House of Representatives and achieves a so-called "red sweep" (where the president's party holds a majority in both the House and Senate), allowing the newly elected president Donald Trump to lead a U.S. government that can freely spend at will, the yields on 10-year and longer-term U.S. Treasury bonds may continue to soar, leading to higher long-term borrowing costs in the financial markets.

Gundlach is a well-known fixed-income asset investor, leading an investment firm that manages over $96 billion, most of which is concentrated in Treasury-type assets, and the overall investment returns rank among the top levels of fixed-income investment institutions. Therefore, he is referred to by bond market investors as the "new bond king," almost on par with the 76-year-old "old bond king" Bill Gross.

Gundlach's main point is that he believes increased U.S. government spending will require borrowing through the issuance of Treasury bonds, thereby putting upward pressure on long-term Treasury yields. "If the House falls into Republican hands, there will be a lot of debt, and our long-term Treasury yields (i.e., yields on 10-year and longer U.S. Treasuries) will be higher. It will be interesting to see how the Federal Reserve responds to this in the future," Gundlach said on a program on Thursday.

As of Thursday Eastern Time, the competition for control of the House of Representatives has not yet been decided after Republicans gained a new majority in the Senate. The Federal Reserve lowered interest rates by 25 basis points as expected on Thursday, and interest rate futures traders generally expect the Fed to cut rates again by 25 basis points in December, pause rate cuts in January 2025, and then cut rates a total of three times starting in March 2025, with expectations that the target federal funds rate will reach approximately 3.50%-3.75% by the end of 2025.

However, after Donald Trump announced his victory in the presidential election, an economist team from Nomura now expects the Federal Reserve to only cut rates once in 2025, having previously anticipated four rate cuts in that year. David Kelly, the global chief strategist at JP Morgan Asset Management, warned earlier this week that if Trump wins the U.S. election, the Fed may even pause its rate-cutting easing cycle as early as December.

However, the Treasury market confirms that the yield levels on long-term U.S. Treasuries will be far higher than the target rate range after a year of rate cuts. The 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," closed at 4.33% on Thursday, having surged from a low of 3.60% in September to as high as 4.50% in November.

The latest trend curve of the "anchor of global asset pricing" suggests that the Treasury market is betting that future long-term rates will be far above the target rate range of 3.50%-3.75%. The main logic behind this is that the persistently high cumulative government debt level in the U.S. requires the government to spend more on interest payments and the so-called "borrowing new debt to pay off old debt." Therefore, the Treasury market expects that the scale of borrowing needed by the U.S. government in the future will be much larger than it is now Although the Federal Reserve's policies (such as interest rate cuts) affect short-term rates, the pricing level of long-term rates (such as the yields on U.S. Treasury bonds with maturities of 10 years and above) is more influenced by the market's expectations for future economic prospects, inflation expectations, and government fiscal conditions.

From a more macro perspective, the 10-year U.S. Treasury yield, as the most important benchmark for the risk-free rate in financial markets, serves as a reference for many long-term financial instruments globally, such as the benchmark yield for global corporate bonds and the 30-year mortgage rate, which is crucial for the U.S. mortgage market. Some countries that rely on U.S. financial strength often use the 10-year U.S. Treasury yield as their own anchored risk-free rate.

Notable U.S. Treasury investors like Jeffrey Gundlach have expressed concerns about the challenging fiscal situation of the U.S. government. The fiscal year 2024 has just ended, and the U.S. government budget deficit exceeded $1.8 trillion, which includes over $1.1 trillion specifically allocated to cover the financing costs of the accumulated $36 trillion U.S. debt.

“Trump said he would implement tax cuts... he is very supportive of cyclical stimulus policies,” Gundlach stated. “So in my view, long-term U.S. Treasury yields will face tremendous pressure. I believe the impact of this election result is extremely, extremely important.”

If the Trump administration extends the tax cuts from 2017 or introduces new tax cuts, it could significantly increase the already massive debt burden at the national level in the coming years, worsening the already troubled fiscal situation.

Nevertheless, Gundlach, who accurately predicted the U.S. economic recession, stated that the likelihood of President Trump pushing the U.S. economy into a "recession" remains low.

“I do believe that Trump's victory will significantly reduce the likelihood of an economic recession that the market has been worried about recently,” Gundlach said. “Of course, you could argue that Mr. Trump has lowered the chances of a recession by promoting this economic agenda in simple English over the past three months.”

Some well-known Wall Street strategists, including veteran strategist Ed Yardeni, have warned that the "bond vigilantes" may become active again and push the 10-year U.S. Treasury yield up to 5%. The term "bond vigilantes," coined by Yardeni, refers to market forces that push up yields and lower bond prices to force adjustments in fiscal and monetary policy. The original "bond vigilantes" emerged in the 1980s when the U.S. was experiencing a prolonged period of abnormally high inflation.

Veteran strategist Yardeni stated, “This is a new day for America and a new day for the U.S. Treasury market. The fact that Trump has garnered so much support gives him tremendous power not only in the U.S. but globally. Given the already large deficit, the bond market has reason to be concerned about continued stimulative fiscal policy.” From a theoretical perspective, the 10-year U.S. Treasury yield is equivalent to the risk-free interest rate indicator r in the important valuation model of the stock market—DCF valuation model. In the absence of significant changes in other indicators (especially the expected cash flows on the numerator side), and even under the baseline scenario where the numerator is expected to decline during the earnings season for U.S. stocks that began in October, the higher the denominator level or the longer it operates at historically high levels, the more the valuations of risk assets such as U.S. technology stocks, high-risk corporate bonds, and cryptocurrencies, which are at historically high valuations, face a contraction