Bracing for Change

At first glance, the outcome of the US elections seemed unfavorable for US Treasury bonds. President-elect Donald Trump’s proposed import tariffs are expected to boost US inflation, and many investors are skeptical that the high US fiscal deficit will be reduced over the next four years.

However, Treasury yields have held up well under the circumstances, and bond market volatility has decreased. In contrast, reactions elsewhere ranged from optimism in US credit markets to some unease in Europe and apprehension in emerging markets, where the proposed US tariffs could have severe impacts.

What We Expect

Major policy shifts that would affect the bond market are expected over the next year, including changes to:

• Taxes: Congress is expected to extend Trump’s 2017 tax cuts, which expire at the end of 2025—though with debate over amounts and what is included. Trump also campaigned on a tax cut to 15% from 21% for companies with domestic production.
• Tariffs: Trump has proposed import tariffs of 60% for China and 10%–20% for all other countries. Investors should take these at face value rather than count on negotiations to lower actual rates, in our view; in the medium term these tariffs are likely to raise inflation.
• Immigration: Reducing immigration and deporting illegal immigrants were campaign promises, and action is expected on both, which should tighten the US labor market and could be disruptive to the US economy.
• Deregulation: The prospect for less regulatory scrutiny under the new administration has boosted hopes for mergers and acquisitions, but many Republicans hold antitrust views, which should rule out an ultra-permissive environment. In the short term, deregulation is likely to be a tailwind for earnings and equity markets.
• Foreign policy: Trump’s appointments confirm expectations for a high-pressure approach to China and Iran. Of note, appointees to foreign policy positions so far have been mainstream Republicans, rather than from the far right.

Out of these expected developments, taxes, tariffs, and immigration could potentially drive US inflation higher and prompt action from the Federal Reserve, which raises a concern for bond investors: the independence of the central bank under a Trump presidency. We believe that Trump will wait until Chair Jerome Powell’s term ends in May 2026 if he decides to replace him—and Powell has made it clear that he plans to stay until then.

Another area of concern for bond investors: The $8 trillion fiscal deficit seems unlikely to decrease and may well expand thanks to the likely extension of tax cuts and the difficulty of cutting expenses when 70% of the US budget is non-discretionary.

US: Visions of Inflation

Immediately after the US elections, expectations for Fed rate cuts in 2025 dropped, suggesting that the potential for higher inflation over the next year is top of mind for US investors. The market’s inflation expectation in the short term has also doubled since the beginning of August.¹

Despite the inflation concern, the post-election Treasury market was orderly. In the two months leading up to the elections, the benchmark 10-year Treasury yield climbed some 75 basis points (bps), but after the elections, Treasury yields appeared to establish an equilibrium, with the 10-year mostly in a range of 4.3%–4.45% (Figure 1).² Of note, hedge fund manager Scott Bessent—who is viewed as more moderate than Trump on tariffs—was nominated to head the Treasury department on 22 November, which helped calm the market and drive the 10-year yield to the high 4.20s.

Is the 10-year Treasury yield on its way to 5%? Having climbed from 3.63% in only two months, the yield is more likely to move lower first, in the fixed income team’s view. But a swing back toward 5% seems possible as policy details emerge, and very likely if the US deficit is not addressed.

Optimism in the US Credit Market

Unlike Treasury bonds, US credit was swept up in the risk-asset rally following elections, thanks to the potential for lower corporate taxes and less regulatory scrutiny under the new Republican administration.

The average spread for US investment-grade credit tightened to 77 bps,³ its lowest level since 1998, and high yield corporate bond spreads fell to their tightest levels since the global financial crisis. Triple-C credits have returned an astounding 17% for the year through mid-November.⁴ Strong demand has made it difficult for investors to buy credit securities in quantity.

Amid the optimism, our high yield team has become more cautious. Valuations appear stretched: Third-quarter earnings so far look healthy on their own—with two-thirds of companies meeting or beating expectations—but the extent to which they exceeded expectations is down from the second quarter. With the potential for higher inflation and thus fewer rate cuts in the next year, over-leveraged and low-quality companies could be challenged, as well as those affected by higher US import tariffs. The team still sees attractive opportunities in the telecom and healthcare sectors, along with idiosyncratic credits that have the potential to improve.

Resilience in European Credit

In Europe, the credit market may not have shown as much optimism as in the United States, but it was decidedly upbeat—despite low economic growth in the region.

Spreads were tight, fundamentals were strong, and defaults have been low, according to our European credit analysts. Third-quarter earnings have been positive, with the financial sector reporting one of its best earnings seasons ever. The outlook was also bright: European banking regulators may come under pressure to rethink requirements after new capital rules were postponed in the United States; on the corporate side, large multinationals with production in the United States should benefit from US tax cuts.

If the United States introduces higher import tariffs, our fixed income team believes that the European Union may respond in kind, potentially leading to trade tensions that could damage profits and economic growth.

Emerging Markets: The Big Picture

Our emerging markets debt team sees several likely outcomes if the proposed US import tariffs and other policies are implemented based on the administration’s campaign proposals:

• China is expected to introduce more stimulus measures, support its manufacturing sector, and weaken the yuan to offset the impact of higher US tariffs. The government will likely also diversify its exports, which helped it sustain export levels when faced with higher US tariffs and trade restrictions in 2018–2019.
• Tariffs can be expected to directly hurt open economies that are highly dependent on trade, including many higher-quality emerging markets in Asia (which could also face a headwind from the weaker yuan) and Eastern Europe. Conversely, large, closed economies, as in India and Indonesia, should fare much better.
• The US dollar may stay strong, posing challenges for emerging markets assets. The currency has already gained 3% this month as the US economy has remained resilient.⁵ If a rise in inflation slows the pace of US rate cuts or results in a hike, interest rates could also favor the US dollar.
• An increase in US oil and gas production, a priority for President-elect Trump, should lower prices, an advantage for oil importers such as India, but it should not affect other commodity markets, a relief for commodity producers in Latin America.

The Broad Brushstrokes

The definitive outcome of the US election has reduced volatility in the US bond market and provided a clearer picture for the future. With an orderly US Treasury market and renewed optimism in the credit sector, a soft landing for the US economy appears to be underway, in our view.

Going forward, we are closely watching the economy to see if it will strengthen versus others to the point of “US exceptionalism.” We are also monitoring whether the incoming administration will formulate a concrete plan to reduce the US fiscal deficit and how the country’s trading partners will navigate US policy changes.