🔋Bond, Treasury Bond
Trump’s new Treasury secretary called former secretary Yellen a political puppet, but is he any different?
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Everyone loves talking about stocks. Meta has gone up a record 20 consecutive days in a row, NVIDIA is the golden child of stocks, but could AI profits be in trouble after Deepseek? The S&P500 has achieved two 25% return years in a row with confidence in stocks at record highs. For better or worse, the bond market is the forgotten one. Even though it doesn't get the same attention or returns as stocks, the bond market is underneath every business and consumer and is bigger than the stock market on the global level. Plus, bonds are going to get a lot more exciting.
As you may know, the large US deficit is not funded with freshly printed currency, but financed with Treasury securities (aka debt) that has a slated maturity. The US Treasury has an auction of bills, notes, and bonds of varying duration and price which are primarily purchased by banks. Bonds have long durations of up to 30 years, notes around 10 years, and bills between 4 weeks and 1 year. Most of the time, longer-maturity securities demand a higher interest rate due to uncertainty about future economic growth and inflation which are the primary drivers of interest rates (rough rule of thumb is the 10-year treasury interest rate = GDP + inflation).
The government can only sell bills/bonds that have demand in theory, but there is tremendous demand for US debt of nearly all durations regardless of how large the debt pile has gotten. If the financial sector is spooked about inflation or the prospects for the economy, that has huge ramifications for interest rates in the US. This also if a reason that sometimes the yield curve (long bond yield - short bond yield) goes negative, signaling that things aren’t quite right.
Higher interest rates since 2022 have resulted in higher interest expense for the US government. Higher interest rates affect the re-financing costs of the US government just like businesses and consumers. Last week I touched on the budget breakdown of the US including interest expense, which was more than $1 trillion in 2024 (merely paying for past government spending).
In the last few years under Yellen, the US treasury has been financing debt with primarily short-term bills instead of bonds. There are many arguments and sophisticated reasons why, but it is a debated topic. Some suggest that a prudent government wouldn’t want to lock in longer-term bonds at high rates knowing they will lower them in a few years, while others that the market was demanding shorter-term securities like money market funds. Some go as far as suggesting nefarious motives to stimulate the economy under a Biden administration before the election. While bond experts have a field day arguing the topic in much greater detail than I do, there are still important things to understand about the new administration in charge.
Trump has elected Scott Bessent as the new Treasury Secretary, replacing Janet Yellen (who in her resignation warned about the unsustainable US fiscal path, despite doing little to discourage it while in charge). Bessent was one of those criticizing Yellen for issuing shorter-term securities to aid the Biden administration. In theory, if Yellen was artificially suppressing the supply of bonds, this would increase their price and thus decrease the bond yield as bond yields and prices are inversely related. That means that borrowing costs for corporations and consumers would stay lower and help the economy run smoothly. At the same time, more treasuries mean less demand, lower prices, and higher yield. This yield can help banks make profits off deposits, and help corporations who have cash earn a bit extra which can boost the balance sheet and stock prices.
Since so much debt was issued in the last few years, the higher proportion of bills leaves interest coming due very soon which creates more decisions on how to once again finance that spending. So far Bessent has followed Yellen’s financing strategy and not switched from bills to longer-duration bonds as financing. It appears he will work closely with Trump to align Treasury policy with Trump policy. They are also hoping Federal Reserve Powell plays ball and can help as well. All else equal, issuing more bonds than bills should increase bond interest rates which would be financially tightening and could be detrimental to the economy. Bessent is likely hoping Trump can help lower interest rates along all durations by stimulating energy production, lowering taxes, and negotiating favorable trade deals. He is also hoping to work closely with Powell to lower interest rates which will be more stimulative and keep government refinancing costs lower.
Assuming Trump can be successful, they may engineer lower interest rates and be able to start issuing more bonds without cratering the economy. As I’ve mentioned in previous articles, there are a lot of cracks in the economy already and it may not matter much what policies happen if we enter a business cycle recession. If money starts flowing into the safety of bonds because of recession, interest rates will go down (demand and price of bonds go up) for the wrong reasons. Whether the Treasury or Federal Reserve like it or not will not matter much in this scenario.
Newly appointed Treasury Secretary Scott Bessent’s aggressive criticism of Yellen/Biden has yet to materialize in Treasury policy change. The mentioned policy aims could be harmful to the economy without substantial improvement from other Trump policies. A potentially more aggressive treasury secretary, or one committed to a more aggressive President is another risk in the markets that should not be taken lightly. Until next week,
-Grayson
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