It Is Beginning to Look Like a Debt Emergency

 It Is Beginning to Look Like a Debt Emergency

By Benjamin Picton, Senior Macro Strategist at Rabobank

Meditations In an Emergency

It’s now less than a week to go until the USA decides who is going to be their next President. The state of the political discourse recalls the ‘dramatic crossroads’ meme, where the respective labels attached to the sunny uplands and the grim castle of doom is a Rorschach test to confirm our political priors.

I’ve chosen my words deliberately to say that the USA will be deciding on their next President - rather than the next ‘leader of the free world’ - because one of the options on the table is a more isolationist approach to trade and foreign policy where the USA may decline to perform the leadership role, instead prodding oftentimes recalcitrant allies into shouldering more of the global security burden.

That could draw the curtain on the ‘Team America World Police’ neocon phase, or even Woodrow Wilson’s “making the world safe for democracy” idyll, if you prefer to cast your view further back. What’s now clear is that the bond market and the DXY is becoming sensitized to the potential implications of another Trump win.

US 10-year yields were down almost 3bps overnight, but are up more than 55bps since the Fed cut rate in mid-September. Americans who had been holding out for rate cuts before they went house shopping are again contending with mortgage rates beginning with a 7-handle, because US mortgages tend to be priced off the long end of the yield curve.

The shape of the curve is telling. While the OIS futures strip has pared back prospects for further rate cuts from the Fed this year, the 2s10s Treasury spread has continued to steepen. The 2s10s was still inverted at the beginning of September, but now records a positive slope of 15.5bps even as the whole curve has shifted higher. Curiously, the 2s30s spread has not steepened at all since the Fed cut rates.

What does this tell us? In a nutshell, markets are banking on fewer rate cuts in the near term and a decade ahead where inflation may be higher than we have grown accustomed to in the recent past. Why might that be? As Donald Trump’s odds of winning the election improve, markets are re-pricing assets to reflect a state of the world in which the Trump policy suite is implemented. Trump himself is a big spender who favors sweeping tax cuts and universal tariffs that most economists will tell you are inflationary, but a Trump win isn’t the only bear case for bonds.

Harris herself is no fiscal hawk, and there is also a renewed uneasiness over the global debt burden and the likelihood of that debt burden growing further as nations confront higher spending on health, aged care, national defense and interest expenses. More on that later.