Bond Markets May Get What They Want

 | Mar 23, 2012 | 12:00 PM EDT
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After losing in Clinton White House debates over the appropriate size of stimulus, James Carville noted that the bond markets "always get what they want." Ask any observer with a dog in November's presidential race whether a Republican or Democratic White House might prove more to the liking of the fixed income masters of the universe and you're likely to get skewed responses.

Indeed, an analysis of President Obama's 2013 federal budget, House Budget Committee Chairman Paul Ryan's, R-Wis., competing "A Blueprint for American Renewal," and the increasing likelihood of Mitt Romney's nomination in the wake of his Illinois presidential GOP primary victory seems to reinforce two things:

• Democrats and Republicans will carry very different fiscal policy messages into the November elections, and the ideological contrasts will prove a political Rorschach test for investors and politicos alike.

• Despite being driven -- or driven into conflict -- by Tea Party voters, the GOP seems strangely reticent about amping up criticism of the president and his administration regarding the deficits.

The fact is, President Obama has added as much to the national debt in his first three years as George W. Bush did over the entire eight of his two-term administration. That's $3.9 trillion, and more than a quarter increased between Fiscal 2010 and 2012. You can argue, as did Atlantic magazine's Derek Thompson, that Obama has been less of a spendthrift than a victim of plummeting federal revenue. But the stimulus bill produced reports of such shameful waste -- if not self-dealing by some of its authors (read Peter Schweizer's book Throw Them All Out) -- and the Obama era has become so synonymous with annual trillion-dollar deficits, that these defenses seem hardly worth considering.

Nevertheless, even while young-gun Chairman Ryan has put himself and the House GOP majority at risk by diligently taking aim (for a second straight year) at the screwed-up tax code and unsustainable entitlement programs at the heart of America's fiscal problems, there has been hardly a peep from the party's presidential candidates. And this applies most notably to the former Massachusetts governor, whom as a self-professed uber-businessman with widely questioned conservative credentials should want both sane financing and the support of fiscal-hawk conservatives more than any other. (I know, Romney quickly endorsed the Ryan budget (again), but you won't hear him doing it again, and again, or again. Bear with me.)

The simple math comparing the Ryan and Obama budgets is that Ryan would move toward a balance of outlays and revenues consistent with a far smaller government. He would spend $2.4 trillion less over the next five years and, even while reforming the tax code, assume a trillion dollars less in revenues. According to fact sheet from Bankrupting America, the resulting deficits would be $1.4 trillion smaller. These differences become even more pronounced over a 10-year window. Obama, for his part, would raise both taxes and spending above the long-term historical average to similarly reduce deficits and debt as a percent of GDP, although not as much and leaving a permanently bigger federal role in the economy. (For an excellent tutorial on the importance of relative budget baselines, see Bush-era NEC director Keith Hennessey's March 20-21 blogs at

Thus, for the bond markets, either vision would probably be acceptable, but Obama's tax-hiking route might be preferable. At its best, it would reduce fears of crowding out and (hopefully) even save fixed-income investors from the worst throes of being forced to "play defense" by the hard stop of near-zero interest rates, all while preserving a continued outsized role for Wall Street and federal debt financing. Ryan's fiscal plan, by contrast, would rely more on root-canal spending cuts, which investors might doubt Washington's resolve to sustain more than they might the resumption of higher rates on upper income individuals (reverting to but ultimately being pushed beyond levels that worked just fine during the Clinton years).

Nevertheless, despite the Ryan plan's arguably higher ground for fiscal hawks, Romney, the GOP's emerging standard-bearer in November, hardly ever drills the administration for its trillion-dollar deficits.

Indeed, in his carefully scripted victory speech Tuesday night, Romney, in pointing to key "choices" facing voters in November, hardly referred to the debt and declined to even use the word "deficit." His only mention was eloquent, but hardly specific:

"I see an America where we know the prospects for our children will be better than our own; where the pursuit of success unites us, not divides us; when a government finally understands that it's better for more to pay less in taxes than for a few to pay more; where the values we pass on to our children are greater than the debts we leave them; where poverty is defeated by opportunity, not enabled by a government check."

Why the no-glow on deficits and red ink? After all, had current Indiana Governor and Bush-era Director of Office of Management and Budget Mitch Daniels run and found himself in Romney's place, he would be using both phrases in virtually every other sentence.

There are two reasons.

First, Romney's embrace of a Reaganesque 20% tax cut for all Americans -- without any granularity on offsetting and base-broadening cutbacks in tax breaks or deductions -- may be hard to defend with regard to its budget impact, even giving him the benefit of the doubt regarding "dynamic scoring." The Reagan cuts, while magnificent in their incentivizing of savings and investment, and thus growth, nevertheless unfolded amid an uptick in deficits that took almost 15 years to even temporarily tame.

Second, Romney, perhaps angling to run as more of a centrist during the general election and govern as one if elected, may be trying to preserve his options in seeking a future bipartisan solution to America's fiscal mess.

With the trifecta of the currently divided Congress's likely having to raise the $16.4 trillion debt ceiling, extend the Bush tax cuts, and enact alternative savings to head off a devastating defense spending "sequester" shortly after the elections (i.e., a "lame duck" session), my guess is Romney is being driven more by the first than the second of these reasons. I wouldn't hold my breath expecting Romney to suddenly go off message in the afterglow of beating Obama to confirm his critics' worst fears regarding his squishiness on spending or revenues.

Nevertheless, one might reasonably hope that, perhaps after the lame ducks buy a couple of quarters' time by kicking the can into the spring, that Romney might be able to lead Congress toward a grand bargain that might eerily resemble the package of tradeoffs recommended by Obama's own Simpson-Bowles deficit reduction commission in late 2010. And if the history of the Reagan era is any guide, tax reform would give Republicans cover to agree to net new revenues as part of a fiscal fix setting U.S. debt on a more sustainable course.

Meanwhile, if the president is re-elected, gridlock might return as investors' best friend as the Bush tax cuts expire before being rebooted at even more skewed rates for rich and poor with the help of a likely restored Democratic Senate.

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