Don't celebrate too early in the US stock market! Bond giant: Trump 2.0 may force a halt to interest rate cuts

One of the world's largest bond fund management companies, Pimco, has warned that the economic plans of U.S. President-elect Trump could lead to an "overheating" economy and may force the Federal Reserve to halt interest rate cuts, posing a risk to the stocks that surged after Trump's victory.

Pimco's Chief Investment Officer, Dan Ivascyn, stated that the rally in U.S. stocks following a significant Republican presidential victory could reverse. The S&P 500 Index and the Nasdaq Composite Index both soared to record highs last week, driven by market expectations that Trump would implement tax cuts, deregulation, and increased trade tariffs during his second term.

However, he cautioned that these "reflation" policies could trigger inflation in an already "strong momentum" U.S. economy.

Ivascyn told the Financial Times, "It's not as simple as a one-way reflation trade; risk assets shouldn't be blindly optimistic." "You have to be careful with your wishes," he said. With U.S. inflation still above the Federal Reserve's target, "there are some risks that the prosperity triggered by these policies could re-influence inflation expectations or actual inflation."

He said, Trump's policies are being introduced at a time when economic growth momentum is sufficient, which could lead to an overheating economy.

Ivascyn's comments respond to concerns from other investors and strategists that the reaction of higher-risk asset classes to last week's election results is inconsistent with the possibility of rising inflation and long-term tightening monetary policy. In recent years, expectations regarding the path of U.S. interest rates have been a major driver of U.S. stocks.

The S&P 500 Index rose more than 4% last week, marking the largest single-week gain of the year, but Trump's victory also pushed Bitcoin to an all-time high and drove the junk bond spread (the premium paid by low-rated borrowers relative to U.S. Treasuries) to its lowest point in 17 years.

Meanwhile, due to rising inflation expectations, government bonds faced significant selling earlier last week, although the 10-year U.S. Treasury regained ground after Federal Reserve Chairman Powell stated that it was too early to assess the substantive impact of Trump's policies.

While Ivascyn does not expect "massive inflation," he indicated that Trump's policies could support long-term growth and warned that, "we could certainly return to a point where the Fed becomes a bit concerned, and the market starts to unwind some of the rate cut pricing," adding that "this means being cautious about risk asset valuations."

Following a series of strong economic data releases in recent weeks, the Federal Reserve has begun to slow the pace of monetary policy easing. Last Thursday, the Fed lowered interest rates by 25 basis points to a target range of 4.5% to 4.75%, a slowdown from the massive 50 basis point cut in September.

Last week's market pricing indicated that traders have also begun to reduce bets on Fed easing policies in 2025, now expecting a rate cut of less than 1 percentage point by the end of next year Ivascyn stated before the Federal Reserve announced its interest rate decision that the "threshold for another rate hike will be very high," but "the more realistic scenario is that rates will remain unchanged for much longer than people realize."

He mentioned that this would not be a "friendly scenario for the commercial real estate market," and "this could pose some problems for certain sectors that have recently rebounded on the expectation of a Fed rate cut."

However, Ivascyn pointed out that even before Federal Reserve policymakers need to intervene, "the market has often done much of the heavy lifting for the Fed," meaning that the market may begin to digest changes in inflation and interest rate outlooks without the Fed signaling.

Ivascyn indicated that at some point, betting on rising inflation and interest rates could push U.S. Treasury yields to levels that are unfavorable for the stock market, making U.S. Treasuries an attractive investment and thereby diminishing the appeal of stocks.

He stated, "There are practical limits to how high Treasury yields can go before they start to negatively impact risk assets," and that "this could lead to a reversal of some positive market sentiment and economic momentum," with "the market becoming a sort of regulator."