There is an adage in markets that stock investors are optimists and bond investors are pessimists.
As the ticker tape adjusted on Wednesday to Donald J. Trump’s victory, stocks soared in a sign of bullish enthusiasm for his policies of tax cuts, deregulation and stimulative government spending (as well as relief that the election had concluded with a clear winner).
Those same policies, however, have been met with unease among bond investors, who fret about government largess and the resurgence of inflation under the president-elect.
That concern has been reflected in rising yields on government bonds, which means investors expect to be paid more in interest in exchange for lending to the government.
Those began to climb weeks ago, as investors anticipated a Trump win, and on Wednesday the yield on 10-year Treasury notes jumped as much 0.2 percentage points, a huge move in that market. It now stands at 4.35 percent, up from around 3.8 percent at the start of October.
But hang on. Isn’t the Fed cutting interest rates? And aren’t yields just something for farmers to worry about?
Treasury yields, which have been rising, are like the market’s interest rates.
A farmer’s yield is the amount of a crop they manage to harvest once it has been planted and nurtured. It’s a reward for the farmer’s work.
Similarly, a bond yield is the total amount investors expect to make on the money they have invested (or lent, a bond is a form of debt, after all), both from interest payments and the return of the borrowed money.
A risky borrower — one with a lot of outstanding debt, or not enough income to easily cover payments — is less likely to repay all the borrowed money and so is expected to pay higher interest rates on a loan as a result.
When it is the United States government doing the borrowing, that risk is typically seen as negligible. Therefore, yields on government bonds, or Treasuries, effectively reflect just the interest rate investors are demanding from the government to lend it money, and determining what that rate should be comes back to the expected path for growth and inflation.
And because they’re a base line of what to charge the lowest-risk borrower, Treasury yields are used as a benchmark for all sorts of consumer interest rates, including those for home mortgages.
But wait, doesn’t the Fed set interest rates?
Yes, it does. But it sets very short-term rates. Its main tool is known as the federal funds rate.
Though the Fed’s interest rate policy does influence most other interest rates in the United States, all the way up to yields on 30-year Treasury bonds, it becomes less of a factor the further out you look. Investors in long-term bonds worry more about what’s going to happen to growth and inflation over months or years than what the Fed is doing now.
On Thursday the Fed is expected to cut its rates by another quarter of a percentage point, having lowered rates by half a percentage point when it met in September. It is lowering interest rates because it considers inflation to have slowed enough for it to begin taking the brake off the economy, fearful that keeping interest rates elevated for too long could push the country into a more pronounced downturn.
For the Fed, it is too soon to adjust monetary policy based on the potential economic impact of the next president’s campaign promises. The central bank is responsible for managing the economy as it is now, not as it may be.
But for bond investors, who can speculate on what might come to pass in a Trump administration, the economic focus has already shifted. Economists on both sides of the political spectrum agree that the stimulative effect of Mr. Trump’s policies could heat up the economy. Eventually, that could mean the Fed has to reverse course.
Does any of this matter if the stock market keeps going up?
Higher interest rates can weigh on the stock market. For now, stock investors are focused on the potential for a corporate profit boost, deal making and other expansion that might come with a Trump administration’s light-touch approach to regulation and taxes.
But there are signs in the markets that investors are thinking about the potential for future inflation. A market measure of 10-year inflation expectations also rose on Wednesday, and is close to its highest level of the year.
But even if that doesn’t happen — the rise in bond yields will be felt by companies and consumers in need of borrowing money. Mortgages, for example, are loosely priced off the 10-year Treasury yield, as is a slew of other debt around the world, and already the effect is evident. On Thursday, Freddie Mac reported that the average rate on a 30-year mortgage rose to 6.79 percent this week, the highest since July.
There’s another concern lingering in the back of some investors’ minds.
The U.S. government has already borrowed roughly $35 trillion from investors at home and abroad, including foreign governments. Latest figures from September show it costs the government more than $1 trillion to simply maintain this debt by paying interest, and that figure is 17 percent of total federal spending.
Mr. Trump’s proposals, from tax cuts to fiscal spending, are forecast by economists and analysts to dramatically increase the amount the government needs to borrow.
For some, there is a lingering worry about how much the government can ask for before investors stop lending. That’s not likely to happen soon, but there is still the possibility that investors start to demand more in interest to keep lending, raising interest costs for the government even further.
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