Donald Trump drew cheers from supporters in one of his final rallies of the 2024 presidential campaign, when he vowed to “get interest rates brought way down”.
His Treasury secretary Scott Bessent echoed the pledge a few months later, saying that reducing America’s long-term borrowing costs would be a key priority for the new administration.
But that aspiration will be tested in the coming months as investors navigate cross-currents caused by tariffs, immigration clampdowns and the potential for a deepening budget deficit.
“The investment community in general is certainly uncertain, and perhaps nervous, but it’s not obvious whether they should be more worried about recession or inflation,” says David Kelly, chief global strategist at JPMorgan Asset Management.
Yields on 10-year US government bonds, a benchmark rate for trillions of dollars in assets around the globe, spiked to more than 4.8 per cent following Trump’s election in November, a 14-month high.
They have since receded to 4.6 per cent as bondholders oscillate between worrying about inflation, as the new administration rolls out tariffs on imports from major US trade partners, and fearing that those levies could result in an economic slowdown.
“Higher tariffs — particularly when retaliated against — don’t just raise inflation; they slow economic activity,” explains Kelly.
Trump has already imposed 10 per cent levies on all imports from China, plus 25 per cent duties on steel and aluminium imports and has threatened Mexico and Canada with wider tariffs.
Several senior Fed officials have said these may fuel fresh price pressures, and the central bank has paused a short-term rate cutting cycle that began last year as inflation remains above the central bank’s 2 per cent target.
Beyond the short-term outlook for inflation lie deeper questions about Trump’s policy agenda. Investors in safe haven assets such as Treasuries are unaccustomed to pondering whether a president might force out a central bank chair or launch a global trade war.
Even if those scenarios do not come to pass, the already large gap between the US government’s spending and its tax revenues is likely to widen further, necessitating more heavy debt issuance into a market where several key buyers have already scaled back purchases.
The downfall of UK prime minister Liz Truss in 2022 served as a reminder that investor acquiescence in unorthodox or unexpected fiscal policy cannot be taken for granted — even if the $28tn total of US Treasuries in issue is more than eight times the size of the gilt market.
“The scale and scope of the fiscal deficit could be quite large and could be relatively long term,” says Ed Al-Hussainy, rates analyst at Columbia Threadneedle Investments. “That’s the main thing that could be damaging for the rates market.”
Sonal Desai, chief investment officer of Franklin Templeton Fixed Income, believes that if deficit-expanding tax measures make it through Congress “the market will start becoming more nervous”, adding that it is “very possible” this could be the administration in which a showdown between the president and the Treasury market begins to take shape.
But nobody can say for sure at what point investors might start pushing back against the administration. As Mark Sobel, a former US Treasury official and US chair of think-tank OMFIF, puts it: “Is the debt financeable? It is, until it isn’t.”
Much of the responsibility for keeping investors onside will fall to Bessent, a former hedge fund manager. “The entire market is anticipating that he’s going to be able to run policy in a way that is acceptably expansionary, not unacceptably expansionary,” says Desai.
Bessent will be helped by the intrinsic advantages of Treasuries, including their vast liquidity and the status of the dollar as the world’s reserve currency, as well as the lack of any obvious alternatives.
Robert Tipp, head of global bonds at asset manager PGIM, notes that similar fears about fiscal profligacy and disregard for the norms of economic policy articulated in the early days of Trump’s first administration turned out to be largely unfounded.
He also argues that previous presidents such as Ronald Reagan and George W Bush ramped up defence spending and cut taxes, but America’s debt and budget deficit respectively stabilised as a percentage of GDP (GDP) in each of those administrations.
“The fact of the matter is that pro-business administrations historically have worked out well for the markets,” he says.
But Tipp also acknowledges the potential for disruption, given Trump’s unpredictability. “Is the market bulletproof? No.”
America’s fiscal watchdog, the Congressional Budget Office, has forecast that government spending will exceed revenue by $1.9tn, or 6.2 per cent of US GDP, for the year to September 30.
Adjusting for timing effects, it expects this to grow to $2.7tn — 6.1 per cent of GDP — by 2035, noting that shortfalls are “significantly more than the 3.8 per cent that deficits have averaged over the past 50 years.” The CBO’s estimates only include the effects of legislation enacted up to January 6 — meaning they could rise even further as Trump’s tax and spending plans become clear.
So far, the new administration has made its priority the extension of tax cuts for individuals and businesses that were introduced during his first term and, under the auspices of Elon Musk’s so-called Department of Government Efficiency, slashing federal spending.
Lawmakers in both houses have meanwhile begun work on bills that would lay the ground for more sweeping tax and spending measures. The House Budget Committee last week put forward a budget resolution for the 2025 fiscal year which includes proposed tax cuts of up to $4.5tn and a $4tn increase in America’s debt ceiling, for instance.
According to estimates from the Committee for a Responsible Federal Budget, a non-partisan think-tank, this proposal would increase the deficit by $2.8tn between implementation and 2034 — even after allowing for spending reductions — and result in $3.4tn to $4tn of additional debt over the same period, including interest costs.
Maya MacGuineas, president of the CRFB, said this week that the $2.8tn target “is unquestionably too large, and an astronomical figure given our massive debt burden”. She added that “under no circumstance should lawmakers increase the borrowing allowed under this budget resolution.”
The Treasury market has already absorbed big increases in supply without too much drama, having doubled in size over the past decade. In recent years it has also weathered several threatened and actual government shutdowns over funding bills.
Kelly, at JPMorgan, says that “a narrative that is specifically negative for Treasuries” would be required in order for a big sell-off to occur. “We’ll get a clearer picture as this year goes on, because at some stage they’ll have one attempt to pass a big tax stimulus bill — and if they put significant fiscal stimulus and higher deficits into a tax bill, I think the Treasury market will react negatively.”
PGIM’s Tipp says the “perfect storm” would be a scenario “where any of the potential positives on the budget side, like tariff revenues, are discounted by the market at a time when the budget-negative aspects, like extension of tax cuts, looks like it’s going to happen.”
Investors and strategists also stress that any major fiscal plans would need to be approved by Congress — and while the Republicans control both houses of the legislature, their majority in the lower chamber remains a slim one. The Freedom Caucus, a group of Republican fiscal hawks, has previously called for limits to tax cuts that aren’t backed by commensurate reductions in spending.
“Underneath everything is the belief that Congress ultimately will be fiscally responsible over the long run,” acknowledges Columbia Threadneedle’s Al-Hussainy.
Any signs of a market pushback against heavy additional government borrowing might embolden so-called bond vigilantes — investors who sell government debt in order to force changes in fiscal policy — although the vast size of today’s bond market makes this undertaking harder than it was in the 1990s, when vigilantes forced Congress to work towards a balanced budget. Desai, of Franklin Templeton, predicts they would “only come out to play once it is really clear that you’ve got to the point of — call it intolerable fiscal policies.”
The Fed is still by far the biggest owner of America’s government debt, buying up trillions of dollars’ worth after the financial crisis and during the Covid-19 pandemic.
However, it began shrinking its vast balance sheet in the middle of 2022 under its quantitative tightening programme. Analysts say the absence of such a large and relatively price-insensitive buyer from the market could prove important if issuance rises sharply.
Asian economies are among the largest non-US owners of Treasuries — and speculation has mounted about whether countries like China could liquidate some of their holdings as part of a wider trade war.
“There’s no incentive for China to buy US Treasuries,” says Andy Brenner, head of international fixed income at NatAlliance Securities. “Between the tariffs, and between problems in the Chinese economy . . . they’re using that Treasury money . . . rather than just holding it.”
Fresh Treasury data this week showed that Japan and China remained the two largest owners of Treasuries in December, but both countries had continued to reduce their positions over the course of 2024.
Strategists at JPMorgan added that overall, foreign investors sold a net $50bn of long-term Treasuries in December, the largest net sale since May 2021.
The data follows the release of minutes from the latest meeting of the US Treasury Borrowing Advisory Committee (TBAC) in early February. It reported “moderate foreign official demand for Treasuries in 2024”, with “changes in trade patterns, cross-currency hedging costs, geopolitical tensions and the strengthening of the US dollar” cited as potential factors.
Foreign officials “may be reallocating towards gold as a reserve asset”, according to a paper published by Rashad Ahmed, an economist in the Office of the Comptroller of the Currency, and Alessandro Rebucci, professor at Johns Hopkins University, whose analysis of New York Fed data found that foreign official reserve managers sold around $78bn of Treasuries between November 6 and January 8.
The yellow metal has already hit a string of record highs this year, and analysts at Goldman Sachs have raised their end-2025 price target to $3,100 an ounce, citing structurally higher central bank demand and noting that debt sustainability concerns “may push central banks, especially those holding large US Treasury reserves, to buy more gold”.
But many observers are sceptical that large-scale selling of US government debt could take hold, not least because few other asset classes could offer the yield, creditworthiness and liquidity of the Treasury market, or the reserve currency status of the dollar.
“The Chinese are unfortunately stuck — as is most of the world — with a true lack of alternatives,” says Desai. “Eventually, a new reserve currency will come along. Are we there yet? Absolutely not, because China has closed capital markets.”
Tipp questions why investors would move away from Treasuries, with a yield of almost 5 per cent, into Japanese or German bonds. These are highly rated, but for 10-year maturities currently yield roughly 1.4 and 2.5 per cent, respectively. “Some other markets may seem to have things more in order . . . but they really don’t have the scale and they’re not without trials and tribulations of their own,” he says.
Strategists also say that offloading US assets could ultimately inflict self-injury on the selling countries. “The moment you start, prices will fall and you’ll be selling into a weaker and weaker market,” says Al-Hussainy. “It just means you’ve taken a massive loss on your remaining Treasuries.”
That leaves investors, both domestic and foreign, in wait-and-see mode, strategists say. For now, “the read through from policies into demand in the Treasury market . . . is actually very muddy,” according to Al-Hussainy.
The sheer size of the Treasury market and the diversity of its owners means that other buyers are likely to step in readily where gaps do appear — although the wider market backdrop will dictate the price.
“I see the Treasury market as beginning to be more realistically priced for the outlook on the underlying [US] economy, including inflation, which is still clear and present,” says Desai.
If geopolitical tensions escalate dramatically, the Treasury market should theoretically benefit from its haven reputation, sending prices higher and yields lower. It is other, riskier asset classes such as equities that could be hit first — bringing their own concerns for a president who has historically regarded the stock market as a gauge of his popularity.
Treasuries are “where worried investors go to get a night’s sleep”, JPMorgan’s Kelly points out. “There are issues out there; there are plenty of things that could go wrong — but a lot of them could blow back and hit other markets harder first.”
Additional reporting by Ian Smith in London and Adam Samson in New York