Trump "crushes" the Federal Reserve! Is the $28 trillion market rebound prospect shattered?

The hope for a rebound in the U.S. government bond market, which has a scale of $28 trillion, may be fading as Trump's return to the White House is expected to introduce fiscal expansion policies that could suppress the extent of future rate cuts by the Federal Reserve.

The Federal Reserve lowered interest rates by 25 basis points on Friday, following the central bank's initiation of the current easing cycle in September with a significant 50 basis point cut.

However, the market's outlook for further rate cuts has been overshadowed by expectations that key policies from Trump, such as tax cuts and tariffs, will lead to accelerated economic growth and rising consumer prices. This could raise concerns at the Federal Reserve that significant rate cuts next year might trigger a rebound in inflation, thereby undermining expectations that lower borrowing costs would drive a rebound in bonds after weeks of selling.

“We believe one of the main impacts of the election is that it will lead to the Federal Reserve cutting rates more slowly than previously expected,” said Tony Rodriguez, head of fixed income strategy at Nuveen. “We now expect fewer rate cuts from the Federal Reserve in 2025, and they will be spaced further apart.”

Data from UBS Global Wealth Management shows that since mid-September, U.S. Treasury yields have surged by more than 70 basis points, recently recording the largest monthly increase since the global financial crisis of 2008. This increase coincides with Trump's rising support in polls and betting markets in October.

Federal funds futures indicate that investors now expect rates to drop from the current range of 4.5%-4.75% to about 3.7% by the end of next year. This is about 100 basis points higher than expectations in September. Strategists at Bank of America Global Research have also recently adjusted their short-term target for U.S. Treasury yields from the previous range of 3.5%-4.25% to 4.25%-4.75%.

Federal Reserve Chairman Jerome Powell declined to speculate on what impact a new U.S. government would have on monetary policy on Thursday. He stated that the rise in yields may reflect an improvement in economic prospects rather than a warming of inflation expectations. The consumer price increase in September was the lowest in three and a half years.

Nevertheless, this week, inflation expectations measured by U.S. Treasury Inflation-Protected Securities (TIPS) surged, with the 10-year breakeven inflation rate rising to 2.4% on Wednesday, the highest level in six months.

Dan Ivascyn, chief investment officer at bond giant Pacific Investment Management Company, expressed concern that a rebound in inflation could force the Federal Reserve to slow down or pause rate cuts, stating, “I think the worst-case scenario the market faces in the short term will be inflation starting to accelerate again.”

The so-called "red wave" scenario refers to the Republican Party controlling both the White House and both chambers of Congress, which would make it easier for Trump to implement tax cuts and provide more room for Republicans to pursue their economic agenda.

While Republicans are expected to hold at least a 52-48 majority in the Senate, the final control of the House of Representatives remains unclear, with counting still ongoing Andrzej Skiba, the head of U.S. fixed income at BlueBay Asset Management, Royal Bank of Canada, stated that he is preparing for further sell-offs in long-term bonds. He said, "If the tariff policies are implemented as we expect, this could prevent the Federal Reserve from cutting interest rates."

Rick Rieder, Chief Investment Officer of Global Fixed Income at BlackRock, wrote on Thursday that assuming the Federal Reserve significantly cuts rates in 2025 would be "giving money to the market," and noted that bonds are more attractive as an income-generating asset than as a bet on rate cuts.

Focus on the 4.5% U.S. Treasury Yield Level

The rise in U.S. Treasury yields has had little impact on the stock market so far, which has surged significantly due to the easing of election uncertainties, with investors reacting to the possibility of strong economic growth, pushing the S&P 500 index to a record high.

However, if yields rise too much or too quickly, it could pose problems for the stock market. Higher yields provide competition for stocks as investments while increasing the cost of capital for businesses and consumers.

Angelo Kourkafas, a senior investment strategist at Edward Jones, stated that when the 10-year U.S. Treasury yield approached 4.5% or higher last year, "it triggered some pullbacks in the stock market. This is a level that people are paying attention to."

Others are concerned that the return of so-called "bond vigilantes"—investors who punish profligate governments by selling bonds—could excessively tighten financial conditions, as higher government bond yields would raise borrowing costs for everything from mortgages to credit cards.

According to recent estimates by the Committee for a Responsible Federal Budget, Trump's tax and spending plan could increase debt by $7.75 trillion over the next decade.

Bill Campbell, a portfolio manager at DoubleLine, expressed concern about the U.S. fiscal situation following Trump's election and is betting that long-term U.S. Treasury yields will rise further. He said, "The red wave will complicate matters."