President Bill Clinton’s chief political strategist James Carville famously said in 1993: “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 want to come back as the bond market. You can intimidate everybody.”
Three decades later, will an incoming President Trump and Republican Congress be intimidated by the bond market? Will rising interest rates and their potential negative economic impact wrought by “bond market vigilantes” unnerve the Trump and the GOP?
To begin, who are these “bond market vigilantes”?
In addition to domestic and foreign investors in US Treasury and other fixed-income securities, the ‘bond market’ also includes a community of securities analysts and economists. And almost all these folks, or “vigilantes” if you prefer, are anonymous market participants. That’s an important characteristic in an era when some politicians threaten retribution on public dissenters.
In the current setting, moreover, the anonymous vigilantes may be incited by a most influential and unlikely-to-be-intimidated editorial page of The Wall Street Journal. Its writers have recently been expressing skepticism about Trump’s campaign promises on trade policy and some aspects of his proposed tax cuts.
Even before the November 5 election, numerous bond market observers were becoming more nervous about what a possible Trump victory might mean for the Federal deficit and inflation. The 10-year US Treasury yield jumped from 3.98% a month before the November 5 election to 4.26% on election day. Following incoming President Trump’s impressive electoral victory, the same yield rose to a mid-November peak of 4.45%. And while the stock market initially jumped after the election, rising yields appear to have dampened some of the enthusiasm for stocks.
Supply Side Shocks
The recent bond market jitters surrounding the incoming Trump administration’s policies reflect a variety of concerns. One is the potential inflationary impact of tariffs. Plans to curb immigration and deport immigrants are also feared to reduce labor supply and boost wage inflation. Promised tax cuts raise concerns about rising Federal deficits. Finally, some are beginning to fret about Trump’s stated intention to reduce the Federal Reserve’s independence.
From a timing perspective, the tariff and immigration issues are probably the financial markets’ most immediate concerns. That’s because the President has broad executive authority on tariffs and immigration without needing Congressional approval. While higher tariffs and a lower immigrant labor supply may not be immediately implemented after Trump is inaugurated, the financial markets will react to forecasts of their potential inflationary consequences.
Fiscal Stimulus
On fiscal policy, the specific tax and spending proposals submitted by the President early next year will be followed by speculation about whether Congress will go along. In so far as Trump’s behavior during his first term is a guide, there is however reason to believe that he’ll threaten reluctant Republicans with political retribution in the 2026 Congressional election party primaries.
In next year’s debates on fiscal policy, specific proposals will be scrutinized by Congressional Democrats, the media, and the research community. The White House will likely respond publicly and aggressively to counter such criticisms and will enlist surrogates to combat criticism. But such pushback, especially if it is financially and economically unconvincing, will not assuage a nervous bond market.
At the center of fiscal policy controversy will be the Congressional Budget Office (CBO). It is tasked with assessing an administration’s tax and spending proposals. If the CBO strongly disagrees with the Trump administration about the deficit implications of his proposals, the question will arise about whether Trump will demand that Congress replace key senior CBO officials?
Erosion of Fed Independence
Next year, the issue of the Federal Reserve’s independence may also receive greater scrutiny. Candidate Trump said that a president should become more involved in making monetary policy decisions. Of course, a president’s opinions on monetary policy have traditionally been communicated in at least two ways. First, there is a long tradition of irregular meetings between presidents and the Chairman of the Federal Reserve. Second, any president’s preferences for the conduct of monetary policy can be (and have been) publicly communicated via speeches and media interviews.
But candidate Trump proposed something different. He argued for regular and formal face-to-face consultation, with the US president directly participating in Fed decision making meetings. As a practical matter that would make the Fed less independent.
Beyond public exhortation, another way a president can influence monetary policy is via appointments to the Federal Reserve Board. Fed Chair Jerome Powell’s four-year term does not end until January of 2026. Powell has recently stated that he would not leave earlier. Any pressure from the Trump Administration to force him out before his term expires would be a clear negative for the bond market.
One option floated by some of Trump’s supporters is for an early nomination and Senate confirmation of Powell’s successor. But an appointment of a Trump loyalist could raise serious doubts about the Fed’s independence. That would be especially the case if the new Fed Chair nominee welcomes the president to attend FOMC meetings or is seen as an advocate of the Trump administration’s trade and fiscal policies.
In addition to appointing the Fed Chair, a President can replace other Fed Governors when their terms expire. However, for the current six other Governors no seats expire in 2025, and just one seat becomes open at the end of January in 2026. Accordingly, the Trump White House may choose to announce the new Chair and a replacement for the expiring seat at the same time next autumn to emphasize tighter control over the Fed.
Presidents of the 12 regional Reserve banks participate with the Governors on the policymaking Federal Open Market Committee. Traditionally those presidents have been selected by regional Reserve Bank boards of directors and approved by the Federal Reserve Board. Any Trump administration attempts to influence those appointments would be seen as another step toward reducing the Fed’s independence.
Still another way by which a president can influence monetary policy is by getting Congress to amend the Fed’s legal status. For example, a president may ask Congress to adopt legislation that would enable the executive (the White House) to fire the Fed Chair or to increase the number of Board seats (i.e., ‘Fed-packing’) with allied appointees.
It Could Happen Here
President-elect Trump has recently nominated Scott Bessent to be his Secretary of Treasury. The role is, of course, an advocate for an administration’s economic policies. But the head Treasury job is often filled with an eye on pleasing the financial markets, as Bessent is likely to do. Still, even an initially credible nominee could lose credibility if the secretary is seen as touting flawed policies.
If bond market participants dislike the policies and personnel in the incoming Trump administration because they are perceived to stoke inflation, increase budget deficits, or erode the independence of the Federal Reserve, then President Trump will be confronted next year with rising bond yields.
Critically, Fed Chair Powell has stated that further interest rate cuts depend on further progress in lowering inflation. Should that not happen and the FOMC pauses rate cuts, Powell and the Fed are apt to receive strong public criticism from President Trump.
Which raises even larger questions.
Would the Trump administration allow a rebelling bond market and a tumbling stock market to force a change in its economic policies? The answer is probably “no”, considering Trump’s aversion to any form of capitulation to criticism.
But will Trump’s party wobble? The response of some Congressional Republicans representing ‘purple districts may hinge on whether the economic fallout from dipping bond and stock markets might jeopardize their re-election chances.
Given the Republicans’ narrow margins of control in the next Congress (in the House and Senate), only a few Republican rebels would be sufficient to deny Trump his legislative policy wish list. In the upcoming 2026 off-year elections, all members of the House of Representatives and twenty Republican Senators will be up for re-election. Most may be intimidated by Trump’s threats to oppose them in party primaries, but some may be more concerned about losing office in the general election if the markets and economy sour.
Markets as Guardrail
In sum, the bond market is a potential guardrail against bad economic policy, particularly if by ‘bad’ we mean policies such as tariffs and net outward immigration that stoke inflation and cause the Fed to adopt policies that bring it into conflict with the White House.
Importantly, the Treasury bond market is not partisan. Its only concern is an adequate rate of return on lending to the US government. It reflects the will of savers looking for safety, liquidity, and positive returns greater than inflation. The bond market is loyal to finance, not politics. And the bond requires an independent Federal Reserve to safeguard its interests.
The White House may not be politically constrained in the next two years, given pliant majorities in Congress, friendly courts, and sympathetic regulators. But Washington is not the only game in town. New York, London, Tokyo, Frankfurt, Singapore and, yes, Beijing—as financial centers—matter, too.
Whether the Trump White House is aware of those realities is something we are about to discover.
