Presidential Power vs Bond Market Bite

The power that the US President wields over financial markets has become abundantly clear since the start of President Trump’s second term. Utilizing the Emergency Economic Powers Act of 1977, he has imposed copious tariffs to address the large and persistent trade deficit that he sees as a National Emergency. With a clean sweep in both House and Senate it requires defectors to stop some of his bills passing, but the IEEPA gives ultimate control on International Economic transactions to the President.  However, the bond market appears to still have ultimate power, in April the President had to blink and scale back the proposed tariff card.  Spiking government bond rates across the curve, but primarily focused on the 10-year rate, forced the institution to retreat due to the impact this metric has on American consumers, businesses and homeowners. Ultimately the market uses bonds to measure the risk of any project, the flight away from what is perceived the most liquid and safe asset was a significant shake up to plans.  The critical tail risk scenario is that nearly 9% of US National Debt is held by the Chinese government and could be liquidated onto the market as a final bargaining tool. The Japanese were originally impacted by a 24% tariff; they hold over 12.5% and the breakdown in trust could cool their appetite for the US Debt market. 

The uncertainty continuing to be caused by the flip-flop trading terms has now had a measurable impact.  The US bond market sold off last week as Moody’s downgraded the US long-term and senior unsecured ratings from AAA to Aa1, this was the last of the three major rating agencies to downgrade the US.  J&J and Microsoft, in the view of the agencies, now represent more capital security than the US government.  It has been 14 years since S&P initially downgraded the US from AAA status; this came 4 days after Congress raised the debt ceiling. The increase in 2014 was to $14.694trillion with various mechanisms for added Presidential spending, after numerous suspensions President Biden approved a ceiling of $31.4trillion in 2021, breached in 2023 and has since been suspended. One of the concerns flagged in Moody’s report was the deterioration of the interest costs, spiking rates on the back of President Trump’s policies has put greater concern on the ability to refinance and even promoted Moody’s to hold a negative outlook, hinting worse to come. In many ways Moody’s was late to the party on removing the AAA status from the US, the continued ballooning of debt and limited successful efforts to reduce annual deficits have damaged their financial standing. AAA rated Sovereign debt is now limited to about 10 countries when looking across ratings, a selection from Europe, Australia and Singapore.  Germany stands out as it changed its policy on defense spending, not constraining it to the 1% of GDP debt brake and opening a significant investment window. This is being done from a relative position of strength given Germany’s current debt to GDP ratio below 65%, nearly half the US rate.

Bond market fallouts have created political change in recent history, the calamitous mini budget that Liz Truss announced in September 2022, the immediate reaction from the Bank of England was to raise rates and ultimately Truss resigned within a month. This outcome is almost impossible in the US, but it does highlight the critical balancing act that President Trump is playing. Using tariffs as a negotiating tactic can be effective, the terms of trade for outbound US goods will potentially improve. The negative is that any tariff will be paid by the US consumer and unless there is a cheaper US alternative it creates inflation, impacting on the ability of the Federal Reserve to cut rates.  If the US quickly replaces domestically produced goods, then the impact can be muted but it requires domestic investment.  Two major hurdles stand against that currently, the uncertainty from constant changes in policy meaning no CEO wants to commit to an investment with unknown parameters and the increase in rates driving the capital cost higher for investment. Change will happen but the bond market has been shown to have the greater staying power to regulate the volatility of that change. 

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