The spectre of the far right in the ascendency is spooking bond markets. The fiscal outlook for France, and the Eurozone, will remain a concern, even if Rassemblement National cannot garner an absolute majority, due to demographics, climate change and higher military spending requirements. Paul Johnson, Director of the Institute for Fiscal Studies (IFS) in the UK, was brutal in his assessment of both the Labour Party’s and the Conservatives’ fiscal plans: there is a “conspiracy of silence” on the stark choices facing the next government in terms of tax and spend.
However, the biggest implications for bond markets remain on the other side of the Atlantic. President Biden’s performance during the first Presidential debate last Thursday has led to growing calls for him to step down as the Democratic Party candidate. The odds of second Trump term have jumped following the debate, and the chances of a Republican sweep have also risen.
Fully extending the TCJA tax cuts could add $4.6tr to the deficit between 2025-34. Trump’s proposals also include a 10% across-the-board tariff on all trading partners as well as a 60% tariff on goods from China. A partial substitution of tariffs for income tax revenues appears inevitable under a Trump presidency. Policies that threaten to slow the pace of the clean energy transition, or reduce immigration drastically, could also hit the supply-side of the economy, damaging the fiscal outlook further.
Trump may not be able to follow through on some of the more extreme policy proposals being touted. But it is becoming increasingly difficult to envisage a scenario where deficits are brought back down towards more ‘normal’ levels. With term premia still hovering around zero, it is not at all clear that markets have priced in the repercussions for bonds. The risk ahead is that investors balk at funding exorbitant deficits. The slide in the yen past 161 against the dollar is putting additional pressure on the long end of the curve.
