According to Guillermo Felices, a principal and global investment strategist at PGIM, the financial markets are not adequately considering the potential risks of Donald Trump winning a second term as president. This oversight could lead to a significant disruption in the long-duration bond markets, commonly known as a “tantrum.”
The stock market has experienced a significant surge in value since November of the previous year, resulting in both the Dow Jones Industrial Average and the S&P 500 reaching unprecedented levels on Monday.
The market is currently paying close attention to short-term economic data and how it could impact the Federal Reserve’s decisions on interest rate cuts this year.
The optimism in investments with high risk is mainly based on the belief that the Federal Reserve will start reducing interest rates quickly in the beginning of the year. Additionally, it is expected that the U.S. economy will experience a gradual slowdown without causing a recession, thus bringing inflation back to the Federal Reserve’s desired 2% target.
Looking towards the future, certain experts are considering the fiscal and geopolitical implications of the upcoming U.S. presidential election in November and what it could mean for the country moving forward.
In 2017, Donald Trump implemented a tax reform bill that reduced the highest corporate tax rate from 35% to 21%. During his campaign, Trump expressed his intention to decrease it even more to 15% if he wins a second term as President.
Risk of a ‘duration tantrum’ in bond market
There is a potential risk of a significant market reaction in the bond market, often referred to as a “duration tantrum.” PGIM, a major investment management company, expressed concerns about the market’s optimistic outlook for a stable economic transition in the United States.
One of the factors contributing to this concern is the market’s complacency towards the potential risks associated with a Donald Trump victory, fiscal expansion through measures such as tax cuts and increased defense budgets, as well as the possibility of military conflicts escalating.
We believe that if Donald Trump were to become president, it would have a positive impact on the economy. This is because there would likely be an increase in fiscal stimulus through state tax cuts. However, it is important to consider how this stimulus would affect the bond market and the overall economic conditions.
He stated that if the economy remains robust and does not need additional fiscal stimulus, the bond market may become concerned about the sustainability of debt and the possibility of higher interest rates. As a result, we could witness an increase in yields, causing a slight disturbance in the market and leading to unfavorable conditions for risky assets.
Despite facing a significant rise in interest rates to tackle high inflation, the American economy has displayed unexpected resilience over the past couple of years. Both growth and employment have remained strong, indicating its ability to withstand these challenges. The upcoming fourth-quarter GDP growth estimate, released on Thursday, will provide more information on the current state of the economy as the Federal Reserve strives to bring price increases back to their target level.
In the event that the economy is significantly weaker and requires additional fiscal support, a Donald Trump win could potentially benefit the market by providing the necessary boost. However, the market’s response would ultimately depend on the specific economic conditions being faced by the U.S. economy at that particular time.
‘Fiscal risk’ at a time of high deficit
At present, there is a significant concern about the financial risk associated with the high deficit in the United States. Over the past few decades, the fiscal position in the country has been deteriorating. According to projections, the U.S. government deficit is expected to range between 6% and 8% until the end of the decade. Additionally, Fitch, a credit rating agency, forecasts that this deficit will surpass 8% of the GDP every year from 2023 to 2025.
The implication of this is that whoever becomes the president in January 2025 would have limited opportunities to engage in extensive governmental spending or implement the tax cuts that Donald Trump has pledged.
According to Felices, the current market perception is not taking into account the possibility of a two-sided risk. The market is currently assuming that central banks will once again come to the rescue by cutting interest rates, especially if there are signs of economic weakness. Felices, who has previously held a senior economist position at the Bank of England, expressed this viewpoint.
Investors are not giving much attention to the possibility of higher bond yields due to the reevaluation of term premia. The significant concern lies in the fiscal risks caused by the U.S. deficit, which the market will need to address once more.
Therefore, he proposed that both investments that carry a certain level of risk and investments with fixed returns will encounter a more unstable and unpredictable period in the future compared to the relatively smooth performance witnessed by investors in the past year. This is primarily due to
In addition to the tax cuts, experts have also raised concerns about the potential drawbacks of Donald Trump’s plan to impose a 10% tariff on all imports into the United States. This proposal has been heavily criticized for its potential negative impact on the U.S. economy and consumers.
Since Donald Trump was last in office, both the macroeconomic environment and the broader geopolitical landscape have undergone significant changes. These changes include substantially higher interest rates and a geopolitical landscape that is now unrecognizable.
In recent days, Felices has joined a group of strategists who believe that Donald Trump’s unpredictable foreign policy decisions pose an increased threat to the markets and the economy at this time.
According to Dan Boardman-Weston, the CEO of BRI Wealth Management, Donald Trump’s frequent changes in his stance on geopolitical alliances could create greater risks and uncertainty. This is particularly concerning given the ongoing tensions between China and Taiwan, as well as Russia’s conflict in Ukraine. These factors could have an impact on market valuations.
