In Trump We Truss

Donald Trump’s Platform Abandons Fiscal Conservatism

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” -James Carville

Populism is basically making feel-good promises for votes without thinking through the policy consequences or costs — an electoral shortcut, often made in bad faith. Say whatever needs to be said to get elected. It can be done on both the left and the right. Give out gifts, like tax cuts or targeted social spending. This is what makes it the bane of government paper. Think of what Medicare and Social Security did to long-term US fiscal stability, for instance.

Many Americans don’t realize that unfunded tax cuts are the same things in the eyes of the bond market as unfunded social safety net liabilities, but the concerns in the particular case of a potential Trump victory and accompanying red wave could result in much more acute and rapid consequences for the US fiscal integrity than the slow burn of entitlement spending. At least entitlements were initially funded, but those schemes eroded with demographic change.

The current Republican Presidential platform is incredibly expensive and there is no proven reliable way to pay for it. It also will crimp the spending power of the American consumer on a large scale. Top CEOs have confirmed tariff costs will be passed to the consumer . Even if you make generous considerations that Trump’s tariff plan works at spurring a domestic manufacturing boom it won’t happen overnight, and I am betting bond markets won’t give him the benefit of the doubt in the interim.

But here’s the thing, while much of the population may be convinced that tax cuts naturally produce more revenue based on a flawed and colloquial popular understanding of the Laffer Curve, the bond market is more matter of fact. The bond market demands fiscal stability, and Mr. Trump’s agenda won’t work immediately even if it does work. If he is able to implement his economic plans, it could result in the largest sell-off of US Treasuries in modern history.

The bond market takes little on faith, as the YTD high on the MOVE Index (VIX of bonds) suggests. I believe it is so high because if Donald Trump gets elected, you can bet the bond market is going to send some very stern, potentially cataclysmic messages about his unfunded promises.

Markets partially like divided government because it prevents radical economic action from either side. But Trump’s tariff plans don’t require Congressional approval, unlike the plans of Kamala Harris. And any way you cut it, they are a radical departure from current US government revenue collection practices.

The Proof is In The Blood Pudding

In late 2022 Liz Truss was elected Prime Minister of Great Britain. She ended up having the shortest tenure in history because of a disastrous financial market response to her mini-budget which included tens of billions of tax cuts that were not offset by other revenues. Donald Trump’s unfunded policies make those of Liz Truss seem modest. And the fundamental lesson that the bond market won’t take unfunded tax cuts well should be heeded by market participants.

“The Trump campaign has promised a lot, none of which is funded, which we project will produce large deficits and eventually reduce economic growth. The campaign’s promises keep accumulating.” -Kent Smetters of the Penn Wharton Budget Model

Unfortunately, the same fundamental problem with Liz Truss’s unfunded budget exists with Trump’s current platform. With the race currently a coin toss, bond markets are starting to freak out. If Trump wins, I’m hypothesizing they will freak out even more.

Unfunded tax cuts could put an already shaky fiscal framework at risk of rapid deterioration, perhaps the most rapid in modern history. Given the unique role of US Treasury debt as the risk-free asset anchoring valuation models, the consequences could be unprecedented and severe in US and global financial markets. Donald Trump’s unsubstantiated and expensive policy proposals put the Uncle Sam in danger of suffering a similar or worse fate to that which befell Britain in October 2022 — and for the exact same reason.

The stock market is high because the economy is exceptionally strong, inflation is beaten back, and the US consumer has remained very resilient in the face of many risks and headwinds. But one thing the financial crisis taught us is that when bonds deteriorate rapidly, stocks are soon to follow because they are junior in the capital structure. If a company can’t pay their debts then there are no future earnings for shareholders.

The MOVE Index being at levels around $135 suggests daily swings of around 16 to 17 bps, which are incredibly rare and massive moves. I don’t think there’s much of a reasonable explanation for this level of highly elevated bond volatility other than Trump’s radical and untested economic platform. The Republican Party has abandoned its former erudite economic elite in favor of populist promises and the bond market isn’t likely to oblige that change without a hell of a fight.

I run a research service called www.PunkRockTraders.com . We saw the MOVE Index creeping up as Trump's odds for victory started to increase. Since we know that bonds often lead stocks, we advised our subscribers to make a very fortuitous trade on the CBOE Volatility Index last week. To get more timely and actionable trades to insulate yourself from Black Swan risks and to take advantage of bull markets, subscribe to Punk Rock Traders,