Robin Marshall, M.A., M. Phil
Indrani De, CFA, PRM
- The 2024 US elections have been followed by a more modest yield curve steepening in US Treasuries than President-elect Trump’s victory in 2016, to date
- This may be because the result was less of a surprise than 2016, given prediction markets, and that the yield curve has been steepening throughout 2024
- The doubling of Federal debt since 2016, and transition to a higher rate regime may limit the scope of President-elect Trump’s proposed tax cuts and spending plans…
- ...increasing the interconnectedness of US monetary and fiscal policy and the influence of bond market vigilantes
Initial market reactions to the outcome of the 2024 US Presidential and Congressional elections broadly followed the 2016 playbook, when President-elect Trump was first elected, with equities outperforming Treasuries, curves steepening, and the term premium increasing. The main driver has been the mooted tax cuts and fiscal stimulus proposed by President-elect Trump during the election campaign. In fixed income, a steeper yield curve, higher short run inflation expectations and a rise in the term premium all immediately followed the 2016 Presidential election, after similar campaign proposals, as Charts 1 and 2 show, but to date, the evidence is more muted in 2024.
Chart 1 shows the US yield curve began disinverting and steepening in early-2024, as the Fed pivoted towards easing policy, well in advance of the US elections on November 5, and Chart 2 that longer run US inflation expectations have yet to move decisively higher.
Chart 1 US yield curve and US elections
Source: US Federal Reserve, Dept of Treasury. Please see the end for important legal disclosures.
Chart 2 US inflation expectations
Source: US Federal Reserve, Dept of Treasury. Please see the end for important legal disclosures.
The power of surprise, in 2016, may have driven the sharper reaction
This may be because the outcome of the 2016 Presidential election was a bigger market surprise than 2024. In 2016, the betting prediction markets showed Hilary Clinton as strong favourite to win the Presidency, with an 82% chance of success versus only 18% for President-elect Trump, the eventual victor, the day before the election (on the betting platform Predictit). In contrast, in 2024, President-elect Trump was predicted to have a 58% chance of success, according to the betting prediction market Polymarket, and was a clear favourite. Also note that as the prediction market moved in favour of President-elect Trump, the yield curve did steepen in the month before the election.
Increased fiscal activism and the stock of US public debt
Even if the outcome of the US election was less of a market surprise in 2024, rapid growth in the US Treasury market since 2016 may help explain why the yield curve has steepened and the 10 year term premium has increased in 2024.
In Q4, 2016, US Federal debt held by private investors[1] was approximately $12 trn, with $6 trn. held by foreign investors, as Chart 3 shows. This compares with $23.2 trn held by private investors at the end of Q2, 2024, and $8.2 trn held by foreign investors. The twin shocks of the Global Financial Crisis and Covid were the main drivers of this explosive growth in Federal debt, but the 2017-18 tax cuts, infrastructure programmes and the Inflation Reduction Act were other key drivers. Debt levels rose sharply under both Republican and Democrat administrations. It is true that the US dollar’s role as the primary global reserve currency continues, but the decline in the share of foreign investor holdings of US Federal debt, shown in Chart 3, should also be noted (from 50% to 35%).
Chart 3 US Treasury market size and evolution
Source: US Federal Reserve, Dept of Treasury. Please see the end for important legal disclosures.
The new US debt service cost dynamics emerging….
Substantial increases in the stock of US Federal debt, and higher rates, have combined to deliver a rapid increase in US debt service costs and begun to transform government finance. This now means debt service costs are close to $1 trn per annum, and one of the largest items in current expenditure on the Federal budget. Since the average maturity of US Treasury securities over the last 20 yrs is 64 months[2], we looked at the evolution in debt service costs versus the yield on 5 year Treasuries, which is shown in Chart 4. This shows the closer correlation now evident between yield levels and current interest payments, because of the scale of the increase in Federal debt. The Chart illustrates how the growth rate in interest payments accelerated quickly post-Covid, after the initial dip on Covid, in 2020, when zero rates returned.
Chart 4 US Federal debt service costs & 5 yr Treasury yield
Source: US Federal Reserve, Dept of Treasury. Please see the end for important legal disclosures.
….raise the risks from higher yields and bear steepening of the curve
Clearly, as federal debt service costs rise as a proportion of overall federal govt expenditure, the adverse effects from higher yields increase. The fact the 10 yr yield has increased since the Fed began easing monetary policy on September 18th is a concern, in that regard. Note that, as Chart 5 shows, an increase in 10 yr yields during the early stages of a Fed easing cycle is very unusual.
Chart 5 US yield curve and Fed funds rate
Source: US Federal Reserve, Dept of Treasury. Please see the end for important legal disclosures.
The term premium has increased and reflects the fiscal policy shift
Furthermore, if the US economy has left the era of sub-1% bond yields, for the foreseeable future, and federal debt issuance accelerates further, after more fiscal stimulus, it raises the spectre of more difficult Treasury auctions as investors demand a higher term, or risk, premium. Chart 6 shows Fed estimates of the 10-yr term premium (derived from the Kim and Wright 2005 model), which has risen sharply after the last 3 Presidential elections. However, note that it is now near the highs reached during the inflation shock of 2022-23.
Chart 6 US Term premium on a 10 yr zero-coupon bond
Source: US Federal Reserve Board, Kim & Wright (2005). Please see the end for important legal disclosures.
A changing monetary/fiscal policy balance; market support vital
Another factor relevant to the US term premium, and profile for rates in the medium and longer term, is the ongoing increase in US budget deficits and more active role of US fiscal policy, particularly since Covid. Even before the Presidential election, CBO projections[3] showed the fiscal deficit steadily increasing from the current level of 5.6% of GDP to 8.5% of GDP in 2054, even though the projections assume low levels of unemployment.
Large and sustained primary deficits, which exclude interest payments, are forecast to average 0.6% of GDP until 2054, despite low levels of unemployment. These primary deficits and levels of net interest payments are the key drivers. The CBO is forecasting net interest payments will exceed the primary deficit in 2024 (3.1% versus 2.5% of GDP), and that Federal debt held by the public will reach its highest ever level of 107% of GDP in 2029.
The importance of avoiding a spike in Treasury yields
US Treasury market reaction to this unstable projected path for US fiscal deficits may serve as a constraint on the scale of the tax cuts proposed by President-elect Trump in the election campaign (about 3% of GDP), and future infrastructure spending. As Chart 4 shows above, a spike in bond yields would increase net interest payments further, and combined with tariff increases, deepen the risk of a bout of stagflation and debt trap. This suggests a more measured approach to a fiscal stimulus may result, since a positive reception from the US Treasury market has become a key requirement for a successful fiscal policy.
1. Removing Federal debt held by Federal agencies, and Federal Reserve banks, to avoid double-counting.
2. US Department of Treasury data.
3. The Long-term budget outlook, March 2024, CBO
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