How Wall Street Could Wreck The GOP’s Tax Cut Plans
Jonathan Nicholson
6 min read
Republicans’ plan to extend and expand the massive tax cuts for the wealthy and corporations they originally passed in 2017 are at the heart of President-elect Donald Trump’s domestic agenda.
But one of the sleepiest corners of Wall Street is flashing warning signs about the GOP’s plans: the bond market.
The Federal Reserve has been cutting the interest rates it controls, which usually results in lower market rates for loans, mortgages and credit cards. But investors holding U.S. debt have demanded increasingly higher returns on their investments, which has kept the Fed’s actions from having much effect and mortgage and credit card rates stubbornly high.
“The bond market is sending a message that investors are worried about the economic policies dead ahead,” Mark Zandi, chief economist at Moody’s Analytics, told HuffPost.
The rate for a 10-year U.S. bond, the benchmark many interest ratesare based on, has drifted upward significantly since Nov. 5, when Donald Trump was elected to his second term, from around 4.29% to 4.76%.
And it’s not alone. The 20-year bond yield has risen from 4.57% to 5.03% and the 30-year bond has gone from 4.45% to 4.95%.
These rates have steadily increased even thoughthe Federal Reserve has cut interestthree times since September, and even as shorter-term debt rates have been stable.
Stocks generally grow in valueas the economy moves faster, butbond values are tied to inflation. Higher inflation, usually accompanied by faster economic growth, makes bonds worth less, while lower inflation increases their value. So while stocks initially rose for the first few weeks after Trump’s election victory, on hopes for better economic growth, bond values went the other direction, because many of the policies Trump has said he’ll pursue will likely drive inflation up, too.
For example, stricter immigration controls or mass deportations could increase businesses’ labor costs. And tax cuts would increase budget deficits and boost the amount of debt issued by the government, making existing debt less valuable.
“I think there’s just a high level of uncertainty with regard to all that, that also is causing consternation among investors, resulting in them asking for a higher interest rate to compensate for the perceived risk,” Zandi said.
Zandi’s not alone in noting the creep upward in longer-term rates. Douglas Holtz-Eakin, president of the conservative American Action Forum and an economic adviser to John McCain in the 2008 presidential election, noted in a blog post the rise could mean two things.
It could mean investors are thinking interest rates in general are going to be higher, no matter what the Fed does in the short term. Or at least some investors are worriedabout the U.S.’ ability to pay its debts.
“Regardless of which you believe, it is bad news,” he wrote. “The recent move in long rates is a warning to the incoming Trump Administration. It needs to have a view of how its plans for tax legislation, deficit reduction (or not), and cross-border economic policy will affect this recent development.”
In the wake of a recession in the early 1990s, the then-incoming Clinton administration faced sharp internal divisions over whether to provide economic stimulus or focus on cutting the deficit.
Over the objections of liberals in Bill Clinton’scabinet, like then-Labor Secretary Robert Reich, the deficit hawks won out. Clinton passed a budget package in 1993 that would help the government eventually see a surplus for the first time since 1969.
Pivotal in that fight was the bond market, which deficit hawks warned would drive interest rates higher unless Washington showed progress in reducing the budget deficit.
James Carville, Clinton’s campaign guru, was reported to have bitterly remarked that if reincarnation existed, he no longer wanted to return as a president or a pope or a .400 batting-average baseball player.
“Now I want to come back as the bond market,” Carville said of the the power Wall Street had exerted over the administration’s policymaking. “You can intimidate everybody.”
Another reason for bond markets to be nervous is that Congress will need to again raise or suspend the country’s debt limit this year to avoid defaulting on the U.S.′ debt, which would immediately crash the economy.
Treasury Secretary Janet Yellen said Dec. 27 thatTreasury would probably need to start using accounting gimmicks to stay beneath the current limit by mid- to late-January. Exactly how long those tricks will last is unclear, though some economists expect the threat of default to not be serious until at least June or even a few months after that.
If Republicans drag their feet on passing legislation to preserve the temporary 2017 tax cuts, the need to raise the debt ceiling could coincide with that debate, raising the political stakes for debt-wary lawmakers.
The House GOP has been mulling a $1.5 trillion boost in the limit paired with a $2.5 trillion 10-year spending cut. But if Republicans hike it by that amount, it might only be enough to get them through the first half of 2026 — not past the mid-term elections — as Bernard Yaros, the lead U.S. economist for Oxford Economics, wrote in a research note this month.
The nonpartisan Congressional Budget Office has projected the debt will be about $3.2 trillion higher than now as of Sept. 30, 2026, meaning a hike twice as large as the one the GOP is contemplating would be needed to prevent an economy-destroying default. If Republicans wanted to make sure to avoid another debt limit fight through November 2026, they might need to raise the debt limit by $4 trillion, which would be the single-biggest hike ever.
House Speaker Mike Johnson (R-La.) tried to ease fears about debt limit-induced market jitters ahead, telling Fox News that Republicans don’twant to give the impression that adefault ispossible, and said Republicans would pass a debt limit hike as part of the larger bill with the tax cuts.
But there’s a catch to that plan: It’s been almost 20 years since Republicans passed a debt limit bill by themselves, in April 2005. Since then, when the debt limit has been hiked or suspended ― 17 times in all ― Democrats have either passed it or Republicans have relied on Democratic votes to help them do it.
Still, whenasked if he thought the GOP was capable of passing a debt limit hike on its own, Rep. Tom Cole (R-Okla.), who chairs the House’s spending committee, said he thought so.
“But it’s only possible if there’s a lot of other things in there that get some members that have an objection to voting for a debt ceiling or no history of it,” he told reporters.
“We’re not going to lose the full faith and credit of the United States in a Trump administration. He didn’t let that happen the first time, he won’t let that happen this time.”
Zandi said the fiscal picture is much worse now than in the 1990s, when the “bond market vigilantes” trimmed Clinton’s sails. At that time, the amount of U.S. debt in comparison to the size of the entire economy was less than 50%.
“Now it’s 100% and headed north very quickly. And of course, if there are tax cuts, it will go north even more quickly,” Zandi said. “So I think the bond market is beginning to have a lot of agita about that.”
