Morning Note: Market News and our Thoughts on the US Deficit

Market News

The yield on the US 10-year Treasury note has risen to 4.35% after a stronger-than-expected jobs report led investors to pare bets on the Fed’s rate cuts this year. Non-farm payrolls came in at 147K in June (versus 110k expected) and the May and April figures were also revised higher. At the same time, the jobless rate unexpectedly edged down to 4.1% and wage growth slowed more than expected to 0.2%. Traders have eliminated expectations for a July Fed rate cut, and the odds of a September move have retreated to around 80%, down from full pricing of a quarter-point cut before the jobs report.

President Trump secured final passage of his signature tax bill, following a bruising campaign to win over conservative Republicans. The package of tax and spending cuts is expected to add more than $3 trillion to the country’s deficit over the next decade. The news helped support the gold price, which is currently trading at $3,340 an ounce.

Trump said he’ll start sending out letters to trading partners today setting unilateral tariff rates. Countries would have to begin paying on 1 August, he told reporters. He floated the idea that the import duties would range from 10%-70%.

US equities moved higher last night – S&P 500 (+0.8%); Nasdaq (+1.0%) – posting another record close. The market is closed today for Independence Day. In Asia this morning, markets were mixed: Nikkei 225 (+0.1%); Hang Seng (-0.8%); Shanghai Composite (+0.3%). Hong Kong intervened for a third time in a week to defend its currency peg.

The FTSE 100 is currently 0.3% lower at 8,800, while Sterling trades at $1.3650 and €1.1620. The yield on 10-year gilts has fallen back to 4.52%. The FT reports that Chancellor Rachel Reeves is set to announce a review of workplace pension sat her Mansion House speech on 15 July. Changes may include the amount companies and staff set aside for retirement.

Source: Bloomberg

Macro View - Backdoor QE: When Politics Drives Markets.

There are times when politics and policy play a secondary role in financial markets. This is not one of those times. Today, markets are increasingly shaped by shifting macroeconomic frameworks and the evolving “rules of the game.”  When these rules change, they become the most important factor investors must consider.

President Trump has never been shy about expressing his views, and his latest target is Federal Reserve Chair Jerome Powell, whom he has described as a “very average mentally person” and nicknamed “Too-Late Powell,” in reference to Powell’s resistance to cutting interest rates more aggressively.  The pressure is not only rhetorical.  Treasury Secretary Scott Bessent recently asked, “Why would we issue debt at current long-term rates?” That comment was especially notable given that Bessent had previously criticised his predecessor Janet Yellen for shifting debt issuance away from long-term bonds and toward shorter-term bills.

So, what’s happening?

The U.S. is running unprecedented peacetime budget deficits, and those are poised to rise further as new spending proposals take effect.  The political failure of Elon Musk’s recent, high-profile (and unconventional) attempt to rein in the deficit underscores the constraints in place. Realistically, only three areas of the budget have the scale to materially shift the deficit path: healthcare and social security, defence, and debt service.  The first is politically untouchable. The second, geopolitically untenable. That leaves the cost of debt.

The interest the U.S. pays on short-term debt is tied to the Federal Funds rate.  A combination of aggressive rate cuts and a strategic pivot toward funding more of the deficit through short-dated instruments could dramatically lower U.S. debt servicing costs.  That, in turn, would shrink the deficit, without any politically painful spending cuts.  Importantly, Powell’s term ends in mid-2026, at which point Trump could appoint a new Fed Chair, someone far more aligned with his views on interest rates.

If a version of this strategy materialises, what would it mean for asset prices?

In the bond market, particularly at the long end of the yield curve, two opposing forces would collide.  On one hand, the inflationary implications of such a policy could drive long-term yields higher, as investors demand compensation for future inflation.  On the other hand, if the Treasury sharply reduces long-term bond issuance, concentrating instead on the short end, supply scarcity could push long-dated yields lower.  Add to that the mechanical demand for duration from yield-starved investors, and the pressure on long-term yields becomes asymmetric to the downside.

We lean toward the latter outcome.  This policy would, in effect, mimic the mechanics of quantitative easing.  Instead of lowering yields through central bank asset purchases (demand-side QE), this approach achieves the same result via reduced supply of long-dated Treasuries—a kind of "backdoor QE."

Such a strategy would be both deficit-reducing and highly stimulative, attractive to the current administration. However, it carries significant risks.  Chief among them: inflation.  As the prior administration learned, inflation is a political liability.  A weaker U.S. dollar and stronger gold prices would likely follow.  In the longer term, the sustainability of this policy is highly questionable.  The lack of political will to address the deficit through traditional means such as entitlement reform or tax increases, appears entrenched.  Ironically, austerity through spending cuts could backfire by triggering a recession, worsening the deficit it was meant to reduce.

This leaves backdoor QE as a politically palatable, if economically risky, option. It underlines the scale of the challenges confronting U.S. fiscal policy and the profound influence political decisions now exert over financial markets.