Lessons from Liz Truss: When Bond Markets Push Back

Bond markets don't bluff. A historical look at Liz Truss' downfall offers a stark warning for fiscal policy missteps. Is Trump paying attention?

I am your new captain. I know, I know. I am boring you with all the bond-talk lately, but I am simply reflecting to you what Wall Street insiders are talking about around water coolers. WHILE YOU SLEPT, Bloomberg reported that there is a possibility that Chinese officials would be willing to work out some sort of deal with Elon Musk to take the helm of TikTok and avoid an imminent shutdown. Good news for my son and maybe the markets a bit as well. But the real good news are reports that surfaced about Trump’s team considering a more gradual tariff campaign than was initially promised. That would be good news for the markets as it is likely that a worst-case scenario is already factored into the market. If so, that means that the news could give markets a short-term boost, certainly if confirmed.

I am hopeful, and I am sure not alone, that Trump’s strategy team got the message loud and clear from the bond markets which sent a clear message in recent months. Swollen deficits and tariff-induced inflation will not be tolerated. Well, maybe tolerated if done in a measure, disciplined manner. You are probably thinking that Trump and team could care less about what a bunch of bond slinging number crunchers think. It is stimulus and American exceptionalism was promised to the people and it’s that which they will get. I mean who doesn’t want stimulus? Cheers to tax cuts! Once those cuts kick in, surely no one will care about the deficit… whatever that even is. You think so?

Let’s take a look at recent history for some guidance on this question. We must travel back in time to Fall 2022 in the United Kingdom. Liz Truss, a conservative became the Prime Minister. The economy was somewhat stagnant with declining growth, inflation was raging, and the Bank of England was raising interest rates. Stagflation was a real fear. The Truss Administration decided to propose a so-call mini-budget which included sizable tax cuts in order to stimulate the economy. The supply side move, despite her administration’s hopes, was not met with applause from… the bond markets. Check out the following chart. It tells the whole story in one picture.

This chart shows 30-year Gilt yields, the equivalent of the US Treasury 30-year bond. The shaded green area represents Liz Truss’ time spent in the front row of Parliament. That’s right, she set a record for the shortest tenure in British history. How could something like that happen? Well, by looking at the chart, you can probably gander exactly when Truss announced her mini-budget, which included a £45 billion unfunded tax cut. That almost 150 basis-point spike brought those yields to a nearly 3 decades high. The British Pound Sterling was pounded after the announcement as well. When domestic yields rise, the currency typically strengthens, but in this case the currency saw the deficit increase as a weakness. The Bank of England, the UK’s equivalent to the Fed had to jump into action and shore up the currency and financial markets. As a direct result, Truss was forced to resign her post just 44 days after she got the keys to Number 10. Many have argued that the period of volatility in the bond and currency markets marked the beginning of an economic growth spiral that did not reverse until 2024.

Quick and violent. Now, to be clear, there were many other dynamics at play during that time, but there are few that would argue that it was not, indeed the bond market’s pronouncement that marked the beginning of her march to ye’ old chopping block. It is also clear that the US does not have an equivalent to a no confidence vote so it is not likely that Trump would ever find himself in a similar situation, but I simply wanted to demonstrate the power the bond markets command.

Finally, as we have discussed quite a bit recently, Trump is certainly aware of capital markets’ sentiment as it relates to his policies. He is therefore not likely to do anything that would cause US markets to break down similarly to the UK’s under Truss’ administration. It is also highly unlikely that Trump will abandon his plans for tax cuts and tariffs. If done properly, those can be powerful tools which can prop up the US economy, however, threading that needle will be challenging. At the bare minimum, it will take a steady hand and a thoughtful strategy. Hopefully, this morning’s news is a sign that incoming administration will employ such a strategy. Feet on the ground, eyes on the bond markets.

YESTERDAY’S MARKETS

Stocks managed to rally into yesterday’s close for a win, but for the tech-burdened Nasdaq, which lagged as a result of the Biden administrations package of parting gifts that included further restrictions for AI chipmakers. 10-year Treasury Note yields touched some uncomfortable levels during the session but ultimately moderated into the close. Late session rallies are a sign of a potential trend reversal and hopeful bulls will march into today’s session with a bit of hope ahead of key inflation figures today and tomorrow.

NEXT UP

• Producer Price Index / PPI (December) may have ticked up to 3.5% from November’s 3.0%. **This is no sleepy number! It is a leading indicator of CPI, and it has been inching higher, surely worrying Fed officials, which should worry you as well. 👀🚨
• Fed Speakers today: Schmid and Williams.
• Trump cabinet job interviews begin on Capitol Hill today, expect a stream of potential market moving data as the President’s picks take the hotseat.

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