Bond market participants brace for bigger deficits under either Trump or Biden

By Vivien Lou Chen

One possible outcome from the lack of any budget restraint from Biden or Trump is a higher frequency of 'pretty weak' Treasury auctions, strategist says

One of the top takeaways from Thursday night's televised debate between President Joe Biden and his Republican challenger Donald Trump is that the U.S. faces little prospect of any fiscal restraint in the years ahead no matter who wins the Nov. 5 election for the White House. That's because Biden, if re-elected, and former president Trump would probably extend either part or all of the 2017 legislation that led to the so-called Trump tax cuts and includes provisions for households that are set to expire at the end of 2025. Biden has indicated a willingness to extend those provisions for people making under $400,000, while Trump wants to fully extend them. Of course, the ability of each candidate to carry out their policies will also depend on the extent to which they can control Congress. The nonpartisan Congressional Budget Office estimates that an extension of the Trump tax cuts for the next 10 years would add about $4.6 trillion to the deficit, which currently stands at about $1.2 trillion with the government about two-thirds of the way through its fiscal year.See: 5 stock-market takeaways as Biden sees 'incredible pressure' to step aside after debate

U.S. government debt sold off on Friday, pushing yields on 10-year notes BX:TMUBMUSD02Y and 30-year bonds BX:TMUBMUSD30Y to their highest closing levels in more than two weeks.

Read: Trump beats Biden for 'king of debt' title as market braces for crush of federal bonds"There seems to be only a very narrow possibility of fiscal restraint because both candidates are looking to renew all or parts of the Tax Cuts and Jobs Act," said FHN Financial macro strategist Will Compernolle in New York. "I'm not sure where the political will comes from to narrow the deficit," and even a divided government that produces gridlock in Washington "tends to result in the status quo, which is a widening deficit."Lack of fiscal restraint tends to translate into more issuance of U.S. government debt, which now raises questions about whether the $27 trillion Treasury market could see revived fears of waning investor appetite that leads to broader ructions.

In Compernolle's view, "we might see a higher frequency of pretty weak auctions, one of the market signals that there is not demand for higher supply. But that's likely to come in increments, rather than in the form of any bigger disruptions."Treasury auctions are one of the primary methods by which traders and investors have been able to express their views on a seemingly never-ending onslaught of government debt. And parts of Wall Street have been unsettled since at least last year by the possibility that there may be a limit to investors' appetite.One poorly received 30-year auction in November, for example, briefly sent the corresponding Treasury yield BX:TMUBMUSD30Y up by the most in one day since June 2022 and ushered in a period in which weak demand at government-debt sales took a bigger toll on stocks. Shaky auction results were also seen last month.BMO Capital Markets strategists Ian Lyngen and Vail Hartman point to two primary risks they see in their outlook for the Treasury market. One is that inflation rears its head again, resulting in interest-rate expectations being "kicked forward" into 2025.

The other is that the Nov. 5 election outcome produces a Republican or Democratic sweep of the White House, the Senate, and the House of Representatives because "there will be little to prevent even greater deficit spending in the years ahead, as there will be no obvious checks on the fiscal side.""Some split of control between the White House and Congress is our assumption at this stage - which would limit the obvious further growth in deficit spending, even if it would once again put the debt ceiling debate into focus," Lyngen and Hartman wrote in a note this week. Earlier this month, the Congressional Budget Office released updated projections which showed that it expects the federal budget deficit to reach $1.9 trillion in fiscal 2024 or $2 trillion after factoring in certain adjustments. Meanwhile, federal debt held by the public should reach 122% of GDP in the year 2034.

-Vivien Lou Chen

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06-28-24 1550ET

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