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The US economy has shown surprising resilience over the past two years, enduring the worst inflation in decades and a brutal cycle of interest rate hikes, despite sluggish global economic growth. A very strong labor market associated with savings accumulated during the Covid pandemic have long fueled consumption spendings in the service sector. Those two drivers have sustained solid GDP growth, despite the weakness of some cyclical and interest rate sensitive sectors such as manufacturing and real estate. However, the impact of a very tight monetary policy by the Fed is being felt in 2024, as the employment market gradually cools off and allows for a slowdown in wage growth. The Fed had been waiting to be confident that the inflation was finally contained, which Jerome Powell has signaled by announcing that a rate cut cycle is set to begin.
Employment growth stalls, easing pressures on wages but rising fears of a recession
There's still time before the election, and both candidates are likely to flesh out their programs in the coming weeks to try to tip the balance in their favour. Still, Kamala Harris and Donald Trump have already outlined several economic measures that they will push forward if they reach the White House. Unsurprisingly, the philosophy of their agenda differs fundamentally and could set the US economy on different trajectories depending on the outcome of the Presidential and Congressional elections. Beyond a bipartisan agreement to protect the US industry from Chinese exporters, the anecdotical shared proposal of removing taxes on tips, and a common intention to boost the housing market, the Republicans’ and Democrats’ economic programs are almost diametrically opposed.
Kamala Harris’ economic program is logically in continuity with the policies implemented under Joe Biden’s presidency. The Democrats’ platform is a set of redistributive policies where fiscal support to families and low-to-middle income households would be financed by higher taxes on corporates and wealthy households. The emblematic economic measures championed by the current Vice-President are tax breaks for households with children, fiscal support to first-time homebuyers, a higher federal minimum wage, various forms of price control in several sectors (i.e. food, rents, prescriptions, bank fees), and an increase in the corporate tax rate from 21% to 28%.
During Donald Trump’s first term, the US public deficit steadily deteriorated until 2020. While the COVID-19 pandemic led to unprecedented deficits in 2020 and 2021, the Biden/Harris administration has not improved public finance since then. Instead, the federal deficit has continued to rise, approaching 7% of GDP this year and pushing U.S. public debt above $35 trillion, or 120% of GDP.
US public debt has been rising at an ever-faster pace
In the continuity of this trend, the economic programs of the two candidates are not expected to lead to smaller public deficits or a slowdown in the growth of public debt. Schematically, Kamala Harris intends to finance the support targeted to middle-to-low-income households with the rise in the corporate tax and the income tax on top earners. Donald Trump intends to compensate the loss of fiscal revenues from corporate and individual taxes by tariffs on imports from the rest of the world. Most independent estimates show that both programs will hardly be neutral for public finances and that deficits will remain high in the years ahead. According to the latest report of the Congressional Budget Office, the US public deficit is expected to hover around 6% of GDP for the next ten years. Financial largesse by either candidate is likely to worsen the situation.
Key Takeaways: The Federal Reserve Will Lead, but Fiscal Policies Will Set the Tone
The Federal Reserve's monetary policy and the broader economic trajectory will remain the key drivers of bond market performance in the coming years. A Kamala Harris presidency would likely result in strong support for ESG investments, and more stable trade relations which could help contain inflation risks. Conversely, a Donald Trump presidency might drive higher inflation, a stronger dollar, and greater market volatility, particularly for emerging markets and sectors exposed to global trade. In either case, investors will need to closely monitor the Fed's policy and broader economic trends, as these factors will have the largest impact on bond markets in 2025 and beyond.
Government Bonds: Fed’s Role in the Yield Curve
The 2024 election will have implications for government bonds, but the Fed’s rate cut cycle will be the dominant force. The key question remains whether the U.S. economy can avoid recession and achieve a soft landing. However, the election's outcome will shape fiscal policies that could add pressure on long-term rates.
Kamala Harris as president would likely continue the current administration’s approach, with increased spending on infrastructure, renewable energy, and social programs. This could result in higher government debt issuance and upward pressure on long-term yields. Should inflation remain moderate, the Fed's expected rate cuts could flatten the short end of the yield curve, but higher debt levels could keep long-term yields elevated. Harris’s focus on moderate trade policies could help contain inflationary risks, stabilising bond markets to an extent.
On the other hand, Donald Trump in office would likely set a more aggressive fiscal expansion through significant tax cuts and higher defense spending, accompanied by tariffs. These policies could heighten inflationary risks, limiting the Fed’s capacity for aggressive rate cuts. Under this scenario, the yield curve could steepen further, with long-term yields rising more sharply due to higher inflation expectations. Fiscal expansion and potential trade disruptions from tariffs could exacerbate inflation, pushing yields higher as investors demand more compensation for risk.
Regardless of the election outcome, a steepening of the yield curve appears likely. The trajectory of U.S. debt and fiscal deficits will continue to weigh on long-maturity bonds, limiting the potential for significant declines in long-term interest rates. A hard landing for the economy could temporarily push long-term yields lower, but structural pressures from deficits will persist.
The US yield curve is likely to steepen in any case!
Source: Bloomberg
Corporate Bonds: Fiscal Policy and Profitability vs Fiscal Policy
The corporate bond market is especially sensitive to fiscal and regulatory shifts that will differ significantly depending on the election’s outcome. However, the broader economic outlook and the Fed's rate cuts will remain crucial in shaping borrowing costs and credit spreads.
A Harris administration may introduce higher corporate taxes and stricter regulations, particularly in sectors like healthcare, technology, and finance. These measures could weigh on corporate profitability, potentially widening credit spreads as investors seek greater compensation for increased risk. However, Harris’s dedicated support for sustainability and green energy initiatives could benefit the ESG bond market, with government incentives likely spurring increased issuance of green bonds and narrowing spreads in sectors aligned with environmental priorities.
In contrast, Trump’s administration would likely focus on tax cuts and deregulation, which could enhance profitability in industries such as energy, manufacturing, and defense, tightening credit spreads in those sectors. However, Trump’s trade policies, including broad tariffs, could drive up costs for multinational corporations, especially in technology and industrial sectors, potentially widening spreads due to increased costs. Furthermore, inflationary pressures could elevate borrowing costs, creating more volatility in the corporate bond market, particularly for high-yield issuers.
The U.S. High-Yield Spread – The Most at Risk?
Source: Bloomberg
Emering Market Bonds: Dollar Strength and Trade Relations
Emerging market bonds are overly sensitive to U.S. monetary policy and the strength of the U.S. dollar, making the Fed’s rate cuts and the election’s influence on trade policy pivotal.
A Trump-run office, with its focus on aggressive trade tariffs and fiscal expansion, could result in a stronger U.S. dollar, creating challenges for emerging markets. A stronger dollar would raise the cost of servicing dollar-denominated debt for these countries, leading to wider sovereign spreads and weaker currencies, particularly in nations dependent on U.S. trade, such as Mexico. Tariff-related disruptions could also exacerbate bond market volatility in these regions.
On the other hand, Harris is expected to pursue more moderate trade policies, likely leading to a weaker dollar, which would ease debt-servicing costs for emerging markets and mitigate capital outflows. Harris’s emphasis on multilateral cooperation and stable trade relations could provide a more favourable environment for EM bonds, reducing the volatility that often hurts these markets during periods of global uncertainty.
ESG Bonds: A Divergence in Support
The ESG (Environmental, Social, and Governance) bond market has grown significantly in recent years, and the election outcome will influence its trajectory. Harris’ presidency would likely accelerate ESG bond growth, with climate action and sustainability initiatives taking center stage. Increased green bond issuance would be expected, benefiting from favourable policies and incentives for clean energy and infrastructure. Trump would likely scale back domestic support for ESG initiatives, focusing on deregulation and traditional energy production. While global demand for ESG bonds might remain strong, domestic issuance could slow under Trump, especially as renewable energy subsidies are rolled back.