Trump's fiscal expansion policy may hinder the Federal Reserve's rate-cutting pace, casting a shadow over the prospects of a rebound in U.S. Treasury bonds

According to the Zhitong Finance APP, Donald Trump, who is set to return to the White House, is expected to implement a fiscal expansion policy, which may affect the extent of future interest rate cuts by the Federal Reserve and lead to a shaky outlook for a recent rebound in the U.S. Treasury market.

The Federal Reserve initiated the current easing cycle with a 50 basis point rate cut in September and announced a 25 basis point cut as expected on Thursday. However, key elements of Trump's economic agenda, such as domestic tax cuts and external tariffs, will lead to hotter economic growth and higher consumer prices. This casts a shadow over the prospects for further rate cuts by the Federal Reserve. If the Fed is concerned that excessive rate cuts next year could trigger a rebound in inflation, it may slow the pace of rate cuts, thereby weakening market expectations that lower rates could stimulate a rebound in the Treasury market.

Tony Rodriguez, head of fixed income strategy at Nuveen, stated, "We believe one of the main impacts of the election will be to prompt the Fed to cut rates at a slower pace than before. We now think the rate cuts in 2025 will be smaller." The futures market currently shows that investors expect the federal funds rate to drop from the current range of 4.5%-4.75% to around 3.7% by the end of next year, which is about 100 basis points higher than the pricing in September.

Data from UBS Global Wealth Management indicates that as the likelihood of Trump's victory continues to rise, U.S. Treasury yields have surged more than 70 basis points since mid-September, recently recording the largest monthly increase since the 2008 global financial crisis. Bank of America Global Research strategists have adjusted their short-term target range for the 10-year Treasury yield from the previous 3.5%-4.25% to 4.25%-4.75%.

Federal Reserve Chairman Jerome Powell on Thursday declined to speculate on what impact the new U.S. government might have on monetary policy. Powell stated that the rise in Treasury yields may reflect an improvement in economic prospects rather than an increase in inflation expectations. However, the 10-year breakeven inflation rate, which measures future inflation expectations, rose to 2.4% on Wednesday, the highest level in over six months.

Dan Ivascyn, chief investment officer at Pacific Investment Management Company (Pimco), expressed concern that a rebound in inflation could force the Federal Reserve to slow or pause rate cuts. He stated, "I think the painful trade for the market in the short term will be inflation starting to accelerate again."

Andrzej Skiba, head of U.S. fixed income at RBC Global Asset Management BlueBay, expects long-term Treasuries to be further sold off. Rick Rieder, chief investment officer of BlackRock's global fixed income business, also stated that assuming the Fed will significantly cut rates in 2025 is "too aggressive," but he added that bonds are more attractive as a revenue-generating asset (rather than relying on falling rates) The yield on 10-year U.S. Treasuries may rise to 4.5%

So far, the rise in U.S. Treasury yields has had little impact on the stock market. With the uncertainty surrounding the elections dissipating, investors are betting that economic growth will strengthen, pushing the S&P 500 index to record highs.

However, if U.S. Treasury yields rise too high or too quickly, it could pose problems for the stock market, as higher Treasury yields increase the cost of capital for businesses and consumers, while also becoming a competing investment for stocks.

Angelo Kourkafas, senior investment strategist at Edward Jones, stated that when the yield on 10-year U.S. Treasuries approached 4.5% or higher last year, it "triggered some pullbacks in the stock market," and "this is a level that people are watching."

As of the time of writing, the yield on 10-year U.S. Treasuries is at 4.315%.

Others are concerned that as U.S. Treasury yields rise and borrowing costs increase, the return of so-called "bond vigilantes"—investors who punish profligate governments by selling bonds—could lead to an overly tight financial environment. Strategists, including economist Ed Yardeni, have warned that "bond vigilantes" may become active again and push the yield on 10-year U.S. Treasuries up to 5%. DoubleLine portfolio manager Bill Campbell expressed concern about the U.S. fiscal situation under Trump and is betting that long-term Treasury yields will rise further.

A recent estimate from the U.S. Federal Budget Committee indicates that Trump's tax and spending plans could lead to an increase in federal debt by $7.75 trillion over the next decade. The increase in debt, combined with potential tax cuts and government spending, could lead to a resurgence of inflation, diminishing the attractiveness of U.S. Treasuries to investors and prompting them to demand higher yields in Treasury auctions. Additionally, a higher debt burden could raise questions about the government's ability to repay, and rising inflation would also erode real yields