What Trump means for global bond markets

Executive Summary

• Donald Trump has been elected for a second term as President. This will bring more volatility to US markets, and from there Australian bond markets too. Volatility does bring opportunity, however.
• Trump’s policy suite is not fully articulated yet. That makes it very hard to analyse since for many of the policies, the implications of a small policy movement and a large policy movement are different, even if the movement is in the same direction.
• Generally speaking, Trump’s policies suggest higher US yields in the short-term and medium-term via higher inflation, higher growth and higher government borrowing
(though there are caveats around all of those). 
• Australia will experience higher yields vicariously via the US and this will mostly influence the longer part of the Australian curve. The overall position of the Australian economy, however, may well suffer. Australia depends a lot on international trade and any disruption, particularly between the US and China, will cause blowback in Australia.
• For the next few months, however, we expect the assumption of a boost to the economy will be strong enough for there to be an actual boost to the economy. Confidence can be a self-fulfilling prophecy and there is clearly a widespread assumption that Trump’s policies will be effective (he wouldn’t have won the election otherwise).

What Trump means for global bond markets

The US has elected Donald Trump as their next President. As we had written in the WIRE back in July, the initial effect of the election news was for bond yields and equity prices to rise. This was expected as Trump was broadly seen as low-tax and pro-business. Now that Trump is confirmed as the winner, we look a little deeper at his policy mix and think about what to expect in markets from a second Trump term. 

So far, Australian markets have largely moved in sync with the US, but we’re not so sure that’s going to continue. Trump’s “America First” policy is explicitly designed to benefit America – the effect in other countries will be different. The most obvious example here is imposing tariffs. Tariffs are likely to be inflationary in the US, but not for Australia. 

Unfortunately, investors will likely have to expect the unexpected. Trump deliberately creates instability as a negotiating tactic. This will have ramifications for global markets in the form of increased volatility. On the bright side, increased volatility can be a boon for savvy investors as moving prices create opportunities.  Overall, we think the impact of Trump’s policies will be to cause higher interest rates in the US, but the picture for Australia is more mixed. Longer-term interest rates (like the 10 year) will be pulled higher in line with the US, but the shorter-term rates may actually be lower, creating a very steep Australian curve. 

What are Trump’s main policies?

Trump has not produced policy documents with explicit goals for policy making. We did find a list of his pre-election promises, but that needs to be treated with caution, too. It’s not generally a good idea to take any politician’s pre-election promises as binding, and even less so with Trump, who, famously, should be taken seriously but not literally. However, using Trump’s first term as a guide, as well as the tone of comments during the campaign, we can identify six general policy priorities for his second term. These are: 

• Lowering taxes. There has been talk of making the previous temporary Trump tax cuts permanent, as well as other proposals to lower personal and company tax. 
• Isolationism and protectionist trade policy. In his first term, Trump pulled out of international agreements. Trump has made some comically high suggestions for tariffs, and we don’t take those at face value. However, it is very likely that the US will be more hostile to international cooperation in general and free trade in particular. The relationship with China is likely to be particularly tense. 
• Anti-migration policy. We are not sure how literally to take Trump’s rhetoric around mass deportations and de-naturalising of existing citizens. Trump will certainly seek to curb migration, however. 
• Pro-oil and hostility to carbon abatement. It wasn’t as much of an element in this campaign, but the “Drill, baby, drill” idea is likely to make a return. 
• Reduction in the size of the US Government sector. There has been talk of appointing Elon Musk as a sort of Government Reduction Tsar with a mandate to shrink the size of the US Government. Trump may also try to reform elements of the public service to be more in line with his policy goals.
• Socially conservative values. These will have a large impact on the lives of Americans but are less likely to affect international markets. 

Generally, Trump is seen as pro-business, but there are nuances here that could be damaging to the US economy. For many of these items, there is not a simple relationship. Often, a small amount of the policy has one effect, but an overload of the policy has a different outcome. At this point, it’s difficult to know how much Trump intends to move policy – and how successful he will be if he tries. However, with what appears to be total Republican control of all arms of Government, Trump will likely face less opposition in his second term than his first. 

Trump will, once again, have a Republican House and Senate to work with, but the complexion of those Republican politicians has changed. In Trump’s first term, despite holding all three arms from 2016-18, there was still a sizeable faction of non-MAGA members of the Republican party. MAGA was a part of the Republican party, but not the entirety. Eight years later, there are few non-MAGA members of the Republican party in the House or Senate. John McCain famously gave the “thumbs down” to Trump’s attempt to repeal the Affordable Care Act, but he has since passed away. Other members of the Congress that provided opposition are less powerful now too. Mitt Romney did not seek re-election, so will no longer be part of the Senate next year. Mitch McConnell remains in the Senate but has indicated he will retire from his leadership role – he’ll be something close to a lame-duck Senator. There will be much less opposition to Trump’s policy from within the Republican ranks this time around. 

The Supreme Court, too, has seen substantial turnover in membership since Trump’s first election win. Trump himself appointed three justices while Biden has appointed a further one. The current Supreme Court has shown itself to be closely aligned, ideologically, with Donald Trump. 

All in all, we expect a purer and less constrained form of Trump policy in his second term. In Trump’s first term, a lot of bombastic rhetoric was created but policy itself was more constrained. There are fewer external constraints this time around and the question of whether Trump fully intends to implement his more outlandish proposals becomes key. If those proposals were only ever bluster, the second Trump term looks rather like the first. If the internal constraints did serve to take some of the edges off the policy last time, the second Trump term could be a more concentrated form of Trumpism. 

Let’s look at the key elements of Trumpism individually and consider what they mean for markets. 

Lowering taxes 

Lowering taxes is often thought of as being purely a stimulatory measure. Indeed, there is a powerful stimulatory effect from putting money back into the hands of regular people who react by going out and spending it. The obvious reaction is, like we have seen in Australia, a general increase in spending and consumption as the tax cuts come in. 

The immediate reaction for markets is predictable: the increase in consumption triggers an increase in inflation and interest rates. 

The second half of lowering taxes is an increase in the US deficit. This should be kept in sight too. The US deficit is already very large and particularly large considering the generally strong state of the economy. Normally, a strong economy would see a comparatively small deficit. 

Lowering taxes even further will reduce revenue and, presumably, increase the deficit further. The US is already running a deficit of just under 8% of GDP. Trump’s first term (and the large tax cuts he provided) saw the deficit rise from 2.2% of GDP in 2016 to 4.9% in February 2020 (just prior to COVID). We don’t consider the massive rise after COVID as indicative of Trump’s governing style. 

An extra 3% of GDP from tax cuts would put the deficit over 10% of GDP. That’s a lot to borrow each year. Markets are usually quite forgiving of Government borrowing, but every so often the so-called Bond Vigilantes take over and yields rise substantially. This is what happened to Liz Truss in the UK in 2022. This side of the tax cut policy is one where the magnitude will be critically important. A small rise in the deficit would see a small rise in US yields, and this would likely be echoed in Australia. If there is a larger rise, however, and a true vigilante-style reaction in the US bond market, then the Australian market is likely to benefit. 

Eventually, the UK bond markets got their way and UK deficits were materially reduced – but at a cost to growth. A true problem in US bond market liquidity could do almost anything to Australian bond yields, depending on the severity of the original problem. Everything from a rise in yields (because the US Government is hoovering up all the available capital) to a fall in Australian yields (because the markets see AAA-rated Australian debt as a safe option in a catastrophe) is on the table. We think the smaller the reaction in the US is the more likely outcome and it would be echoed with a small rise in Australian yields. Only the truly diabolical scenarios for the US see Australia emerge as a safe haven buying zone. 

Isolationism and protectionist trade policy

Protectionist policy and trade barriers have very different impacts depending on which side of the barrier you are on. 

For the US, the impact is quite textbook. Trade tariffs give higher inflation, lower growth and lower productivity because either the costs of the tariff are incorporated into the total price, or the less-efficiently produced local version is substituted. The higher inflation pushes interest rates higher even as growth falls. 

For Australia, however, the impact of a trade war or general increase in protectionism are different. Australia is an open economy charging very few tariffs. We are very unlikely to respond in a tit-for-tat way to US tariffs. The US increasing tariffs could be deflationary in Australia. There are two mechanisms we can see. First, the Chinese manufacturing capacity still exists and will be looking for new markets. Goods which now attract a tariff if exported to the US might be dumped in Australian markets. For example, should the US bar Chinese-made electric cars from entering then it’s quite likely those manufacturers would look to sell those cars in Australia. That’s the “good” mechanism. 

The more worrying mechanism is that although Australia is not a direct exporter to the US in material size (4.3% of our exports are to the US), our primary export destination is China. To the extent that any potential US trade war does weaken the Chinese economy, it weakens Chinese demand for Australian exports. That’s a pure and simple economic slowdown for Australia with lower growth, lower inflation and lower interest rates. 

Anti-migration policy 

This is a complicated one. There are multiple examples of Trump threatening mass deportations. This went as far as handing out signs saying “Mass Deportations Now” at the Republican Convention. It’s very hard to know how literally to take this threat. 

The fact of massive deportations would be very inflationary we think, particularly for low-skilled wages. There is a large pool of immigrant labour in the US that operates at (or below) the minimum wage. They do a large amount of man-hours but earn comparatively little and so spend very little too. Removing those people would see a large increase in prices for things where illegal immigrants provide labour. The best data we could find was old (2017) but suggested that Agriculture and Construction were the industries with the highest percentages of illegal immigrants in their workforce at 14.2% and 12.3% of the workforce, respectively. 
Food production, in particular, is one industry where changes to the labour rates would have a massive impact on final prices for consumers very quickly. 

However, we must caution that while the fact of mass deportations would trigger material rises in wages, the threat of mass deportations possibly has the opposite effect. An illegal immigrant has very little bargaining power at the best of times, but the widespread threat of deportation would weaken their position even further and so could, conceivably, lower labour costs. 

The impact of this policy is much harder to estimate until we know whether the threat of mass deportations is going to become a reality. 

Pro-oil and hostility to carbon abatement 

This policy area is one that will have very different impacts in the short-run and in the long-run. 

In the short-run, energy gets cheaper. Energy is part of the supply chain for literally every product. Cheap energy is an economy-wide disinflationary force. In the longer term, the impact of climate change on things like construction costs and insurance will be worsened, but that’s going to take a lot longer to play out. 

The lower price of energy would be global. It might well show as lower petrol prices in Australia and hence lower inflation. Since Australia is now an energy exporter, this would possibly also weaken our growth prospects. Both of those suggest lower interest rates in Australia. 

Reduction in the size of the US Government sector 

Trump has promised to slash the size of the US Government sector. Generally speaking, that is disinflationary, but the impacts will vary depending on which Government tasks are no longer performed. 
Trump has suggested he would cut the size of the federal budget by a third. The US Government currently employs around 2.9 million people, but many, many more are employed providing goods and services to the Government. 

This promise, if enacted, should be seen as a massive de-stimulus program. It would also need to be understood in the context of the tax cuts, however. Depending on the relative sizes of these two policies, you get a different outcome, but both impact the overall size of the government deficit and the total size of the borrowing program directly. 

We suggest that lowering taxes might be easier than shuttering entire Government departments, since most Government departments have powerful vested interests, whereas most people like tax cuts. We tend to think the deficit rises, but it’s hard to be definitive at this point. 

Socially conservative values 

This one will have a material impact on lifestyles for many Americans, however it shouldn’t have too much direct impact on the economy. 

About the only impact to Australia we can see is that, if the change in cultural tone is significant enough, you might find that people from affected groups might choose either to leave the US or choose other destinations when migrating. This kind of brain drain would be damaging to the US economy but might benefit Australia. The impact is likely to be relatively small, however.      

So what does all this mean for markets? 

It’s quite hard to know what the medium-term holds for markets based on Trump’s policies. The actual policies are not fully articulated yet. We think the move higher in US rates probably holds in the short-term, though. Most of Trump’s policies are inflationary for the US which means higher rates. But the stronger reason we expect the move higher to hold is simply because confidence is often a self-fulfilling prophecy. 

If a large enough percentage of the US economy believes Trump’s policy mix will be better for the economy in the short-term, then it is better for the economy in the short-term. Confidence like that becomes self-fulfilling. Business decision makers and individual consumers who think the coming period will be economically stronger do things like invest and consume, which creates demand, which makes the coming period economically stronger. 

Notice this confidence argument says nothing about whether the policy does actually work in the long run. For a long time in the 1990s and early 2000s, bank deregulation was considered positive for the economy – but we suspect that post-2008, that view might have changed. For the next few months – the fabled first 100 days – the US economy and US markets will likely be stronger. How they behave after that depends critically on what Trump actually does in that timeframe. 

For Australia, we think the election of Trump creates a rise in yields in the short-term because of the correlations between US rates and Australian rates – this will be felt mostly in the longer end of the curve. However, as the reality begins to set in, we think it becomes clear that an adversarial trade policy from the United States does not help Australia. We escaped the worst of this last time with specific exceptions to US tariffs, but still felt blowback via the relationship between Australia and China. Put simply, Australia does significant business with both the US and with China. The more heated and confrontational that US-China relationship is, the harder it is for Australia to prosper. 

There will be an overtone of volatility for everything too.