U.S. Budget Deficits and Bond Outlook

By Davide Barbuscia

NEW YORK (Reuters) – PIMCO, a major bond manager with $1.9 trillion in assets, has expressed concerns about widening U.S. budget deficits and inflationary trade policies after the Nov. 5 presidential election, which could negatively impact U.S. government bonds, despite potential short-term benefits from a central bank in easing mode.

The firm anticipates a "soft landing" for the U.S. economy as inflation decreases and economic activity stays robust. They believe that a more severe slowdown might actually be beneficial for bonds, as the Federal Reserve would likely cut interest rates more aggressively.

PIMCO prefers intermediate-duration bonds, like five-year Treasury securities, predicted to increase in value with lower interest rates. However, the outlook is less favorable for longer-duration bonds, which could suffer due to U.S. fiscal and trade policies.

Tiffany Wilding and Andrew Balls from PIMCO stated, "High government deficits could push long-term yields higher over time." The Committee for a Responsible Federal Budget estimated that tax and spending proposals from Republican candidate Donald Trump could add $7.5 trillion to U.S. deficits in the next decade, while Vice President Kamala Harris could contribute nearly half that figure.

PIMCO noted, "U.S. deficits will be the biggest loser no matter which party wins." High government debt is expected to steepen the U.S. yield curve, meaning long-term bonds may underperform compared to short-term ones.

Trade policies could exacerbate the bond outlook as anticipated higher tariffs from a Trump presidency could drive inflation and slow economic growth.

PIMCO summarized the situation, suggesting, "The risk of globally disruptive trade policies seems greater under a second Trump term, while Kamala Harris may likely maintain a more targeted approach if elected."

This scenario complicates the Federal Reserve's efforts to return inflation to its 2% target, as they must consider the implications of increased short-run inflation due to tariffs being passed on to consumers, which could raise inflation expectations even amid growth risks from declining real incomes.