Thoughts on the Market: Managing Fiscal Policy Uncertainty Under Trump 2.0

Published on January 30, 2025 by Morgan Stanley

Introduction

In the January 30, 2025 episode of Thoughts on the Market, Morgan Stanley's experts delve into the intricacies of managing fiscal policy uncertainty under the re-elected Trump administration. Hosted by Michael Zesas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research, alongside Matthew Hornbach, Global Head of MacroStrategy, the discussion provides a comprehensive analysis of the current fiscal landscape, recent Federal Open Market Committee (FOMC) outcomes, and the implications for U.S. Treasury yields.

1. Overview of the Episode's Main Topics

The episode centers on two pivotal themes:

• US Fiscal Policy Expectations: An exploration of the fiscal strategies and priorities under President Trump's second term, particularly focusing on tax policies and deficit implications.

• U.S. Treasury Yields Trajectory: Analyzing the factors influencing the recent surge in Treasury yields and forecasting their future path amidst fiscal uncertainties.

2. Insights from the Recent FOMC Meeting

Michael Zesas opens the discussion by highlighting the significance of fiscal policy as a major market influencer. He prompts Matthew Hornbach to share his insights on the latest FOMC meeting.

Matthew Hornbach notes, “Investors came into the FOMC meeting this week with the view that they were going to hear a message from Chair Powell that sounded very similar to the message they heard from him in December” (00:35). The outcome, according to Hornbach, affirmed investors’ expectations that the Federal Reserve would not lower interest rates in the upcoming March meeting, emphasizing a data-dependent approach.

An unnamed speaker adds, “The Fed, as ever, remains data dependent” (01:27), underscoring the centrality of economic data in shaping Fed policies.

3. US Fiscal Policy Under Trump's Second Term

Michael Zesas shifts focus to the fiscal policies anticipated under President Trump’s renewed administration. He outlines the government's budget baseline and the president's fiscal priorities.

Zesas explains, “The real big variable here is the set of tax cuts that expire at the end of 2025” (02:04). These tax cuts, established during Trump's first term, are pivotal in determining the future deficit trajectory. If allowed to lapse, the deficit is projected to decrease by approximately $100 billion next year. Conversely, extending these cuts, possibly alongside additional measures like lifting the cap on state and local tax deductions or introducing a domestic manufacturing tax credit, could expand the deficit by a couple of hundred billion dollars (02:04).

4. Impact of Fiscal Policy on Treasury Yields

The conversation naturally transitions to the recent spike in U.S. Treasury yields. With 10-year yields nearing peaks not seen since before the global financial crisis and rising by about a full percentage point since September, the discussion seeks to unravel the causes.

Hornbach attributes the yield surge to multiple factors, including persistent concerns over the growing deficit and increased government bond supply. He states, “Concerns around the deficit are definitely a factor and in particular, how those deficits create more government bond supply” (03:13). Additionally, market dynamics such as investor momentum and reactions to key events, like the Trump administration’s inaugural actions, have exacerbated the yield movements.

Zesas adds, “they saw yields moving higher and invested in that direction” (04:35), highlighting the role of investor behavior in the current Treasury market volatility.

5. Legislative Process and Deficit Impact

Understanding the legislative pathway for fiscal policy is crucial. Zesas outlines the procedural steps required to extend tax cuts, especially given the slim Republican majorities in both the House and Senate.

He explains, “Extending these tax cuts in the way Republicans want to do it probably means they won't get enough Democratic votes to cross the aisle in the Senate to avoid a filibuster” (05:42). Consequently, budget reconciliation becomes the necessary route, allowing passage with a simple majority. The process involves determining acceptable deficit expansion levels, with key milestones expected by May and intensifying negotiations in the fall (05:42).

6. Upcoming Key Dates and Their Significance

The panel emphasizes the importance of monitoring specific congressional deadlines and events that could influence fiscal policy outcomes and, by extension, Treasury yields.

Zesas points to the March 14 deadline for extending stopgap appropriations, noting, “there will likely be a lot of chatter amongst Congressional Republicans about fiscal expectations” (07:38). This period will be critical for gauging the administration's fiscal strategies and their market implications. Additionally, the fall negotiations on tax provisions and possible tariff adjustments remain pivotal factors that could sway deficit projections and Treasury market stability (07:38).

7. Treasury Yields: Short-Term Volatility vs. Long-Term Trends

Hornbach assesses the potential volatility in Treasury yields driven by fiscal policy uncertainties. He asserts, “Any volatility in the negotiation process will almost certainly show up in treasury yields over time” (07:13). Despite this near-term uncertainty, there is a consensus that yields may trend lower towards the end of the year, contingent on eventual fiscal policy resolutions.

8. Conclusions and Insights

The episode concludes with a consensus that managing fiscal policy uncertainty under the Trump administration will be pivotal for market stability. The interplay between legislative actions, deficit management, and investor behavior will continue to shape Treasury yields and broader market dynamics.

Michael Zesas wraps up the discussion by encouraging listeners to engage with the podcast, fostering a community of informed investors keen on market developments.

Notable Quotes

• Matthew Hornbach (00:35): “Investors came into the FOMC meeting this week with the view that they were going to hear a message from Chair Powell that sounded very similar to the message they heard from him in December.”

• Unnamed Speaker (01:27): “The Fed, as ever, remains data dependent.”

• Michael Zesas (02:04): “The real big variable here is the set of tax cuts that expire at the end of 2025.”

• Matthew Hornbach (03:13): “Concerns around the deficit are definitely a factor and in particular, how those deficits create more government bond supply.”

• Matthew Hornbach (07:13): “Any volatility in the negotiation process will almost certainly show up in treasury yields over time.”

Conclusion

This episode of Thoughts on the Market offers a thorough examination of the fiscal policy landscape under President Trump’s second term and its implications for U.S. Treasury yields. By dissecting legislative processes, deficit concerns, and market reactions, Michael Zesas and Matthew Hornbach provide valuable insights for investors navigating these uncertain times.

For those seeking to stay informed on market trends and fiscal policy developments, this episode serves as an essential resource, encapsulating expert analysis and forward-looking perspectives.

Note: This summary omits non-content sections such as advertisements, intros, and outros to focus solely on the substantive discussions presented in the episode.