Our Global Head of Fixed Income and Public Policy Research, Michael Zezas, and Global Head of Macro Strategy, Matt Hornbach, discuss how the Trump administration’s fiscal policies could impact Treasuries markets.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.Matthew Hornbach: And I'm Matthew Hornbach, Global Head of Macro Strategy.Michael Zezas: Today, we'll talk about U.S. fiscal policy expectations under the new Trump administration and the path for U.S. Treasury yields.It's Thursday, January 30th at 10am in New York.Fiscal policy is one of the four key channels that have a major impact on markets. And I want to get into the outlook for the broader path for fiscal policy under the new administration. But Matt, let's start with your initial take on this week's FOMC meeting.Matthew Hornbach: So, investors came into the FOMC meeting this week with a 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. And I think that was largely the outcome. In other words, investors got what they expected out of this FOMC meeting. What did it say about the chance the Fed would lower interest rates again as soon as the March FOMC meeting? I think in that respect investors walked away with the message that the Fed’s baseline view for the path of monetary policy probably did not include a reduction of the policy rate at the March FOMC meeting. But that there was a lot of data to take on board between now and that meeting. And, of course, the Fed as ever remains data dependent.All of that said, the year ahead for markets will rely on more than just Fed policy. Fiscal policy may feature just as prominently. But during the first week of Trump's presidency, we didn't get much signaling around the president's fiscal policy intentions. There are plenty of key issues to discuss as we anticipate more details from the new administration.So, Mike, to set the scene here. What is the government's budget baseline at the start of Trump's second term? And what are the president's priorities in terms of fiscal policies?Michael Zezas: You know, I think the real big variable here is the set of tax cuts that expire at the end of 2025. These were tax cuts originally passed in President Trump's first term. And if they're allowed to expire, then the budget baseline would show that the deficit would be about $100 billion smaller next year.If instead the tax cuts are extended and then President Trump were able to get a couple more items on top of that – say, for example, lifting the cap on state and local tax deduction and creating a domestic manufacturing tax credit; two things that we think are well within the consensus of Republicans, even with their slim majority – then the deficit impact swings from a contraction to something like a couple hundred billion dollars of deficit expansion next year. So, there's meaningful variance there.And Matt, we've got 10-year Treasury yields hovering near highs that we haven't seen since before the global financial crisis around 10 years ago. And yields are up around a full percentage point since September. So, what's going on here and to what extent is the debate on the deficit influential?Matthew Hornbach: Well, I think we have to consider a couple of factors. The deficit certainly being one of them, but people have been discussing deficits for a long time now. It's certainly news to no one that the deficit has grown quite substantially over the past several years. And most investors expect that the deficit will continue to grow. So, concerns around the deficit are definitely a factor and in particular how those deficits create more government bonds supply. The U.S. Treasury, of course, is in charge of determining exactly how much government bond supply ends up hitting the marketplace.But it's important to note that the incoming U.S. Treasury secretary has been on the record as suggesting that lower deficits relative to the size of the economy are desired. Taking the deficit to GDP ratio from its current 7 per cent to 3 per cent over the next four years is desirable, according to the incoming Treasury secretary. So, I think it is far from conclusive that deficits are only heading in one direction. They may very well stabilize, and investors will eventually need to come to terms with that possibility.The other factor I think that's going on in the Treasury market today relates to the calendar. Effectively we have just gone through the end of the year. It's typically a time when investors pull back from active investment, but not every investor pulls back from actively investing in the market. And in particular, there is a consortium of investors that trade with more of a momentum bias that saw yields moving higher and invested in that direction; that, of course, exacerbated the move.And of course,...
