WASHINGTON — Janet Yellen can’t be happy as bond guru Bill Gross shines a bright spotlight on a fast-emerging risk to US Treasury securities: the November election.
In recent interviews, the former chief investment officer of Pacific Investment Management Co (PIMCO) has talked up European debt as a ready alternative to securities sold by US Treasury Secretary Yellen’s team.
“As we move to November, and something becomes more clear as to who might or who might not win, the uncertainty plus the potential policy implications could impact Treasuries significantly,” Gross told Bloomberg.
Gross’s apparent pivot to Europe comes even after electoral shocks in Paris and Berlin. In European Parliament elections on June 9, France’s Emmanuel Macron and Germany’s Olaf Scholz suffered setbacks versus far-right parties.
French bond yields jumped to their highest level since November as President Macron called a snap election in a bid to consolidate power. German and Italian bond prices plunged, too, as traders assessed the fiscal policy implications of the elections.
Political surprises emanating from the Continent, Gross notes, fit with other big upsets in India, Mexico and South Africa that caught many bond investors on the wrong side of market reactions. Could a US election pitting President Joe Biden’s Democrats against Donald Trump’s Republicans be the next market spoiler?
“What we’ve seen the last few weeks is a reaction to uncertainty, in terms of not only the party that’s dominating, but uncertainty as to what their policies will be,” Gross explains.
As such, Gross adds, “there’s coming a point where European bonds are more attractive than Treasury bonds, in my opinion. In terms of attraction, the German 10-year bonds and French 10-year, their spreads have narrowed significantly in the past month or two relative to Treasuries and today as well.”
Written between the lines in bold font here is how US electioneering may cast a serious pall over the attractiveness of the dollar, the linchpin of global finance and trade. And the daunting task Team Yellen faces staving off a global run on US government debt.
Adding to Yellen’s challenges, a US national debt approaching US$35 trillion just as Washington politics become increasingly toxic.
Extreme polarization is already imperiling Washington’s credit rating. Last August, when Fitch Ratings yanked away America’s AAA credit score, it cited the polarization behind the January 6, 2021 insurrection among the reasons.
Fitch also cited political clashes over funding the US government and raising the statutory debt ceiling among the risk factors to Washington’s credit rating. Such clashes might worry Asia less if not for the fact Washington’s debt is twice the size of China’s annual GDP and more than eight times Japan’s.
Combined, Tokyo and Beijing hold about $2 trillion of US government debt. That vast pool of savings could be at risk if Moody’s Investors Service revokes Washington’s last remaining AAA rating. Surging US yields would upend global markets in unpredictable ways.
America’s sharp mercantilist pivot since 2017 is another worry for Asia’s export-reliant economies. Then-president Trump slapped huge tariffs on Chinese goods and global steel and aluminum.
When Biden arrived, he left Trump’s trade war in place — and added new layers of China-targeted curbs, most targeting China’s access to semiconductors, chip-making equipment and other vital, cutting-edge technologies.
Now, Trump’s plan to slap 60% taxes on all Chinese goods is catalyzing something of a tariff arms race, one that’s drawing retaliation threats from Xi Jinping’s government. Biden just imposed a 100% tax on China-made electric vehicles and the EU followed this week with 38% tariffs of its own.
Never mind that such “policies are more likely to hurt than help the lower- and middle-income Americans they purport to benefit,” says economist Kimberly Clausing at the Peterson Institute for International Economics, a Washington-based think tank.
As trade war risks intensify and cloud growth outlooks, stock markets everywhere could be in harm’s way. As Gross puts it, the US “equity market is valued at historically high levels if looking at price to earnings ratios of the current 21 times.” If GDP slows, he notes, there could be “a problem in terms of valuation at the moment for many stocks.”
That goes, too, for Europe’s economic prospects as the region’s biggest economy, Germany, fends off recession risks. Chancellor Scholz’s Social Democrats and its progressive coalition partners are now left to stimulate growth with a narrower electoral mandate.
Over in France, Macron is smarting after taking a beating from Marine Le Pen’s nationalist far-right party in parliamentary elections. The surprise snap election he announced overlaps with Macron’s government playing host to the Summer Olympics in Paris. Macron’s instinct to fight contrasts with Belgium’s Alexander De Croo, who resigned instead.
“Macron is daring French voters to vote the same way domestically that they did this weekend for the European Parliament – which has long been seen as a protest vote,” says Mujtaba Rahman, an analyst at Eurasia Group.
Macron “believes he can defy the polls by confronting France with a stark choice between the pro-EU, pro-Ukraine and centrist status quo versus the existential risk of a far-right government.”
It’s quite a gamble on France’s future. Polls, Rahman says, suggest Macron’s centrist coalition will fail to win a majority, and if Le Pen’s National Rally picks up the most seats.”
That means “France will be in uncharted waters,” Rahman explains. “Le Pen has said she would partially withhold EU funding, toughen migration policy, infringe on the EU single market by prioritizing French business and limit aid to Ukraine.”
Italy’s Giorgia Meloni had a much better week, continuing her pivot from far-right to mainstream. Along with a solid election showing, Meloni’s government will host the Group of Seven (G7) in the days ahead.
Bucking the far-right trend, centrist European Commission President Ursula von der Leyen also appears to have secured another five-year term. Yet odds are she will be forced to cede ground on immigration and environmental policies to smooth the path forward.
What all this means for fiscal dynamics in the EU is an open question. The outlook for US rates is another wildcard. In May, the core consumer price index slowed to its lowest pace in more than three years.
Despite May’s lower CPI, the US Federal Reserve’s guidance seems “roughly unchanged,” says economist Dominique Dwor-Frecaut at advisory Macro Hive. “Cuts remain the base case scenario but only after the Fed has gained more confidence on disinflation.”
Will Denyer, economist at Gavekal Dragonomics, adds that “even though they had this softer inflation data in hand, Fed policymakers still pared back their rate cut expectations for the year.”
The global implications are uncertain. In the foreign exchange market, the belief that the Fed is committed to its 2% inflation target “means any acceleration of US inflation tends to drive up the dollar, while slower inflation leads the US currency to soften,” Denyer says.
As a result, May’s softer CPI release saw the dollar ease against most currencies. It remains uncertain, though, whether this focus will continue to be the dominant driver of foreign exchange markets in the days and weeks ahead.
“Worries over the outcome of the French parliamentary election could undermine the euro,” Denyer says. “A possible reduction of asset purchases by the Bank of Japan … could boost the yen. But for now, May’s moderation in US inflation and what it implies for US policy and global markets remains the big story.”
Not the whole story, though, as election-year shenanigans heat up in the US. With Biden and Trump neck-and-neck in the polls, global markets will remain on edge.
Kelvin Wong, an analyst at OANDA, says the narrowing of the 10-year yield spread premium between US Treasury notes over Japanese government bonds has made US notes “a less attractive fixed-income investment” for Japanese insurance companies that in turn may reduce their US Treasuries exposure and overweight their fixed income portfolio towards JGBs due to higher odds that the long-term JGB yields are likely to trend higher.
“These potential upcoming fixed income portfolio adjustments from Japanese insurance companies may offer some support to stall the major yen’s weakness against the US dollar,” Wong says.
Yet, as Gross points out, European debt is about to enjoy a moment with global investors just as Yellen’s team is scrambling to maintain demand for a US Treasury debt market that seems past its prime.
“Relative to the US, we see support for European bonds due to smaller fiscal deficits,” says Ann-Katrin Petersen, investment strategist at the BlackRock Investment Institute.
Follow William Pesek on X at @WilliamPesek