Making America great again (MAGA), the deficit and the bond market

Making America great again (MAGA), the deficit and the bond market

How to navigate the volatile and often contradictory news flow of Trump 2.0

Since Donald Trump’s re-election as President of the USA, he has signed 151 executive orders (the most in history for a president’s first hundred or so days). The high volume of orders and the frenetic pace are tactical moves, described by Steve Bannon as the ‘flood the zone’ strategy. The goal appears to be to overwhelm the resources of any opposition to the legislation. Add to this the so-called ‘art of the deal’, characterised by many provocative statements or demands, of which many are walked back later, and you have a recipe for immense financial market volatility.

Is the potential impact of policies being presented objectively?

As they are the custodians of the world’s preferred reserve currency and the benchmark risk-free asset, the US long bond, one would expect US policymakers to try and maintain the trust of global investors (see Why trust matters for investors). Unfortunately, the Trump 2.0 fiscal agenda is full of contradictions, and we are not convinced that the potential impact of the policy agenda is being presented objectively and accurately.

The Department of Government Efficiency (DOGE) has garnered immense attention in the press, with Elon Musk having promised US$2 trillion of savings at a Trump rally at Madison Square Garden. Whether that promise was made in good faith or not, we will never know. The Financial Times (FT) reported that even Secretary of Commerce Howard Lutnick was surprised: the agreement had been that DOGE would target US$1 trillion. Well, Musk has moved on, and so far, savings of US$170 billion have been identified, of which the FT claims only a fraction is likely to be genuine. It seems that the days of US policymakers under-promising and over-delivering to build trust are over… What are investors to make of this? How do we focus on what is important through all the noise? 

Focus on constraints, not preferences

BCA strategist Marko Papic has written extensively on geopolitical analysis. His book Geopolitical Alpha is an important read. He uses a constraints framework for his analysis. He describes constraints as the “immutable reality in a situation” and says, “Preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.”

“We should make market calls and forecasts based not on what policymakers want to do, but on what they must do given their material reality.” – Marko Papic (emphasis ours)

Papic details an array of political, economic, financial, geopolitical and constitutional/legal constraints. While most constraints are factual and apparent ahead of time, there are two important exceptions:

• Constitutional/legal constraints, which are often open to interpretation and changes in legislation.
• Financial constraints: we, and more importantly, policymakers, have no idea ahead of time how markets will react after new policies are announced.

The fact that a policy may subsequently be constrained does not stop it from being announced. The ‘Liberation Day’ trade tariffs, subsequently largely suspended after a negative financial market reaction, illustrate this. We believe the constraints that only gain traction after policy announcement, either financial or constitutional/legal, are the key constraints on Trump 2.0. The policy uncertainty this brings greatly increases market volatility.

The market assumed key individuals, like Treasury Secretary Scott Bessent, would restrain Trump. While many of Trump’s executive orders are already subject to legal challenges, we will focus on financial constraints and specifically those related to the US fiscal position.

Key constraints on Trump policies come after the fact

US fiscal policy at a critical juncture

The US has run structural budget and current account deficits for several decades, in part facilitated by the US dollar’s reserve currency role and US long bonds anchoring portfolios as the world’s risk-free asset. The capital flows associated with these annual deficits have accumulated into massive imbalances. The net debt-to-GDP ratio reached 100% (it has only ever been higher at the end of WW2) and the international investment position, because of the consistent current account deficit, has reached a gross foreign liability of US$62 trillion or 209% of GDP, of which US$35 trillion are liquid liabilities (portfolio investment and derivatives).

Maintaining the trust and confidence of foreign investors is the crucial constraint on Trump 2.0. The ongoing funding requirements are enormous: a budget deficit of US$2 trillion and a current account deficit of US$1 trillion need to be funded every year. But in addition, given the vast capital imbalances, should foreign owners of US assets decide to reduce their existing holdings, the impact could overwhelm markets, driving interest rates higher, lowering equity prices and weakening the US dollar.

Having your ‘own facts’ may not work with global bond investors

The Republicans’ narrow majorities in Congress mean the only way to pass legislation without being blocked by filibuster in the Senate is via the budget reconciliation process. This only requires a simple majority, provided it can be shown not to increase the deficit over the budget window. The Trump administration is working hard to pass a reconciliation bill they’ve named the ‘One Big Beautiful Bill Act’.

“This bill absolutely does not add to the deficit and according to the Council of Economic Advisors will save 1.6 trillion dollars, and the President absolutely understands and hears the concerns of fiscal conservatives… who want to get our fiscal house in order, that’s what the intention of this bill is…” - Karoline Leavitt, White House Press Secretary 19 May 2025
https://x.com/atrupar/status/1924457467431317869

The Council of Economic Advisors, chaired by Stephen Miran, is part of the White House and appointed by President Trump. More impartial sources, such as the Committee for a Responsible Federal Budget, Congressional Budget Office (CBO) and Joint Committee on Taxation come to different conclusions on the One Big Beautiful Bill.

On 22 May the Committee for a Responsible Federal Budget said: “… we estimate that by 2034 the House reconciliation bill would increase debt [and total deficits] by $3.1 trillion, or $5.1 trillion if made permanent.

Per Maya MacGuineas, president of the Committee for a Responsible Federal Budget:
“This plan is nothing short of a fiscal failure. It adds massively to the national debt, it relies on timing gimmicks and false claims about growth, it fails to make the structural spending reforms we desperately need, and it uses the important savings it does find to partially offset tax cuts rather than reduce the debt. The fact that lawmakers passed this bill less than a week after America’s latest credit downgrade and yet another worrying Treasury auction is especially maddening. Will nothing wake our leaders up to the need to take our debt challenges seriously?“

Bond market ‘no fly zones’

International investors’ trust in US policymakers has been severely tested so far during Trump 2.0. Here are what we believe are some international investor ‘no fly zones’ that will result in bond yields spiking and significant pressure to change policy:

• The One Big Beautiful Bill being successfully passed in the Senate without fiscally significant amendments.
• Taxes on capital investment into the US such as interest withholding tax (currently under discussion with the new tax code Section 899).
• Threats to independent monetary policy (Federal Reserve Bank Chair Powell’s term ends in May 2026 – this is likely to take centre stage from early 2026).

What does this mean for investors?

We anticipate an extended period of declining US asset prices and a weaker dollar (see The risks of the US Exceptionalism narrative). Investors should be aware that any of the above events could accelerate these moves and create a crisis. Only much higher interest rates are likely to act as an effective constraint on Trump 2.0 policies.

In our view US long bonds have become trading assets and no longer fulfil a safe-haven role in portfolios. This has important implications for global asset allocations and investors need to ensure their portfolios are positioned appropriately for a very different environment that we believe lies ahead.

Kevin Cousins is the Head of Research at PSG Asset Management.