Trump's $4.5 trillion tax cuts risk making bond markets ‘puke'

Telegraph

23-05-2025

'This is a fate worse than death,' bemoaned Charlie Morris on Wednesday, as the founder of investment advisory firm ByteTree was caught up in the Bloomberg blackout.
Confronted by a blank screen as he sat at his terminal, Morris was one of countless City traders unable to access data or execute trades as Britain's Debt Management Office (DMO) was about to auction £4.25bn of UK government bonds.
The DMO, which is charged with raising money for the Government, was forced to extend the length of its auction while a fix was found.
The drama ultimately proved to be just a temporary hiccup, as the auction letter attracted bids of £11.6bn.
However, the same could not be said across the Atlantic, where bond markets were suffering more serious convulsions.
The US Treasury Department revealed on Wednesday that it had attracted tepid demand for a $16bn (£12bn) sale of 20-year bonds.
This pushed the yield on 30-year Treasury bonds – the benchmark for the cost of long-term US government borrowing – to an 18-month high. It remained above 5pc on Thursday.
'The move reflects a change in the perceptions of investors around the safe-haven value of holding long-dated US paper,' says Joseph Brusuelas, US chief economist at RSM.
'Investors are growing increasingly concerned about the intersection of government spending, taxes, trade, inflation and growth.'
'Magic money tree'
The bond auction was the first since Moody's last week became the last of the three major credit rating agencies to strip the US of its prized triple-A status.
Moody's said the decision was a result of America's mountainous debts, which it said are on track to reach 134pc of GDP by 2035.
Thomas Pugh, chief economist at RSM UK, says: 'It's not a magic money tree in the traditional way, but certainly the US has been able to run deficits that no other developed country would get away with.
'It is a far larger deficit that is far longer than any other country would do, and that's because there's almost an infinite demand for US assets.'
The debt market, however, is going through a regime change, says Pugh, as the end of the low interest rate era pushes up borrowing costs.
And that is before you throw in the effects of Donald Trump, Pugh adds, as the US president is trying to borrow vast sums to finance a package of sweeping tax cuts.
'That is adding to this risk premium effect, where, if you're locking up your money for 10-20 years, there is now a lot more uncertainty on that timeframe than there was three to six months ago,' he says.
Initially, the market reaction to the Moody's downgrade was muted, with a brief rise in yields on Monday petering out by Tuesday.
But by the end of the week, that had all changed, with yields moving higher amid lacklustre demand for 20-year Treasuries.
Concerns rose further after signs of distress also appeared in other parts of the world.
In Japan, an auction of 20-year notes on Tuesday attracted the weakest demand in more than a decade, taking the country's 30-year yield to the highest level since records began in 1999.
'These moves in long-dated bond yields, not just in the US but frankly almost everywhere, are getting a little bit scary,' says Riddell.
'If Japanese government bond yields go much higher, then a lot of domestic Japanese investors – life insurance companies – are then incentivised to sell Treasuries, Bunds or gilts and actually repatriate the money back home and switch that into Japanese government bonds.'
'Big beautiful bill'
Such a move poses a huge risk for Trump.
Money moving from US bonds means that the US Treasury would be forced to increase the yield it offers to attract demand, pushing up the cost of servicing the government's $36 trillion debt pile.
Such an event would come just as the US president has passed the first hurdle in getting his tax-cutting 'big beautiful bill' through the Senate.
The Republican-controlled House of Representatives passed a revised version of his 1,000-page tax bill on Thursday by 215 votes to 214, with Democrats staunchly opposed.
Should it pass the Senate, it will extend some $4.5 trillion in tax breaks introduced during Trump's first term in 2017.
The Committee for a Responsible Federal Budget has pegged the cost of the bill at $3.1 trillion over the next decade – which is about 10pc of this year's GDP. As a result, the Congressional Budget Office now projects deficits near 7pc of GDP in the coming years.
'That's wartime borrowing in a peacetime economy with low unemployment,' says Stefan Koopman, an analyst at Rabobank.
'Perhaps inspired by Moody's downgrade, markets are finally taking notice that the fiscal outlook is completely unhinged.
'There is no serious effort at fiscal consolidation or to reduce the structurally large deficits.'
Those outside the sphere of financial markets might ask, what is the problem with the US running huge fiscal deficits? US administrations – and indeed governments around the world – have long run huge budget shortfalls without the world falling over.
'US presidents have been emboldened by the fact that they seem to have ample fiscal space,' says Bill Papadakis, an analyst at bank Lombard Odier, citing the example of Covid.
'They feel they have the space to do that and obviously that's a dangerous dynamic in that, if you keep doing it, at some point, of course those dynamics might change.'
Tariff turmoil
Many economists have taken solace from Trump's decision last month to suspend his 'liberation day' tariffs following the upheaval caused in financial markets.
'We did see a little bit of Trump reacting to market conditions that were sending warning signs,' said Papadakis.
'The dollar weakened a bit, Treasury yields went up, people started talking about the end to US exceptionalism and after this event he did seem to walk back on some of the announcements he had made.'
But since the tariff onslaught was announced on April 2, the S&P 500 and the Nasdaq on Wall Street have clawed back all their losses.
Riddell warned it could take another drop in stocks for the president to water down his tax cuts, by which time it could be too late.
'Back in February and March, the focus really was all about Doge,' he says. 'It was about Elon Musk. It was about getting the deficit to 3pc and how they were slashing away at the government sector.
'This has massively moved to the back seat now. It is all about corporate tax cuts and the last thing a long-dated bond needs is tax cuts. We need to have higher revenue, not more fiscal easing and this is what makes me nervous.
'It increases the chance of a really violent bond market sell-off at the long end, which will then at some point feed into risk assets and cause a bit of a puke like we saw earlier this year.'