Nobel laureate personally "diagnoses": What's wrong with the big dump of US bonds?

Source: Jinti Data

Investors are debating what factors are driving the rise in US Treasury yields, which in turn has brought volatility to the stock market.

Recently retired New York Times columnist and Nobel Prize-winning economist Paul Krugman has offered his possible explanation.

“The rise in long-term interest rates, such as the 10-year U.S. Treasury yield, may reflect a frightening, gradually spreading suspicion that Trump really believes his crazy remarks about economic policy and will act on these views,” he wrote in an article titled ‘Is an Insanity Premium on Interest’.

Of course, Krugman is not a fan of Trump, and vice versa. But as Trump’s inauguration ceremony on January 20th approaches, the question of what Trump’s agenda will bring undoubtedly becomes the focus of investors’ attention.

Krugman suspects that the market is reacting to the president-elect’s statements on tariffs, while also noting his refusal to rule out the possibility of controlling Greenland and the Panama Canal through economic or military coercion, and referring to Canada as the “51st state” of the United States.

Krugman quoted economists’ ‘near-consensus’ view that Trump’s agenda of high tariffs, tax cuts, and large-scale expulsion of illegal immigrants will lead to a significant increase in inflation, although it ‘may not happen immediately’.

“However, if he (Trump) wants to implement any substantial part of these agendas, the Fed will definitely have to postpone further interest rate cuts. In fact, the Fed is likely to feel the need to raise interest rates again,” Krugman wrote.

The minutes of the Federal Reserve’s policy meeting in December last year were consistent with remarks by Federal Reserve Chairman Powell at the time. The latest released minutes stated, ‘Almost all Federal Reserve officials believe that the risk of inflation is increasing, in part because the incoming Trump administration is considering potential adjustments to trade and immigration policies.’ However, these concerns did not prevent the Federal Reserve from cutting interest rates by 25 basis points last month.

Earlier on Wednesday, Adam Posen, a monetary policy expert and economist who previously served on the Bank of England’s Monetary Policy Committee, said that he believes the Federal Reserve will have to start raising interest rates this summer in response to Trump’s budget plan.

However, investors also heard from Federal Reserve Director Warrell on Wednesday, who expressed support for more interest rate cuts this year and did not believe that the import tariffs proposed by the incoming Trump administration would lead to sustained inflation pressures.

Investors are not yet ready to attribute all of the rise in US bond yields to the uncertainty caused by tariffs and other policies.

Krugman’s article is also a response to an article by Torsten Slok, Chief Economist at Apollo Global Management, published on Tuesday. Slok believes that the jump in the 10-year US Treasury yield from around 3.6% in September to around 4.7% after the Fed’s interest rate cut is very unusual.

“Is it fiscal concerns? Is it reduced foreign demand? Or is the Fed’s rate cut not justified? The market is telling us something. For investors, it is very important to understand why long-term interest rates rise during the Fed’s rate cut period,” Slok wrote.

Investors and analysts are still debating the potential impact of Trump’s tariff plan, whether these plans are just a negotiating strategy, and how much impact they will ultimately have on prices.

At the same time, regardless of the reasons for the rise, the soaring yield is the main culprit for the setback of the stock market after the US election, especially considering the overvaluation of technology stocks.

Mark Hackett, Nationwide’s Chief of Investment Research, said in a phone interview, “I believe the entertainment value of the Greenland incident may outweigh its fundamentals.”

He said, on the other hand, concerns about tariffs are having an impact, but he believes the stock market is “currently in a mode of searching for reasons to sell”.

In other words, after the S&P 500 posted an annual gain of more than 20% for the second year in a row, the market was already “expensive and tired,” and the tariff-induced panic became a good excuse for the sell-off.

When it comes to rising yields, Krugman admits that his preferred explanation “might be wishful thinking.” The economist predicted a global economic downturn in November 2016 when Trump was first elected president, but retracted the prediction a few days later, warning that Trump’s victory could ultimately have a terrible impact, but could help accelerate short-term economic growth.

In his article on Wednesday, Krugman said he didn’t want to push his argument too far, in part because ‘I don’t want to succumb to motivated reasoning.’ He said, ‘Those of us who were shocked by Trump’s rise to power want to see him punished by the market, but we shouldn’t expect instant gratification. The consequences of his economic delusions are likely to take years to truly manifest.’