Nobel Prize winner personally “takes the pulse”: What happened to the plummeting U.S. debt?

Source: Jinshi Data

Investors are debating what exactly is driving the rise in Treasury yields, which in turn has sent shockwaves through the stock market.

Paul Krugman, a recently retired New York Times columnist and Nobel laureate in economics, has offered what he believes is a possible explanation.

"The rise in long-term interest rates, such as the 10-year Treasury rate, may reflect a scary, creeping suspicion that Trump really believes the crazy things he says about economic policy and will act on them," 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 January 20 inauguration approaches, questions about what exactly his agenda will entail are undoubtedly the focus of investors.

Krugman suspected that the market was reacting to the president-elect's comments on tariffs, while also noting that he refused to rule out the possibility of taking control of Greenland and the Panama Canal through economic or military coercion, and called Canada the "51st state" of the United States.

Krugman cited the "near-unanimous view" among economists that Trump's agenda of high tariffs, tax cuts and mass deportations of illegal immigrants would lead to a serious push for inflation, although "it may not happen immediately."

"However, if he (Trump) were to implement any substantial part of this agenda, the Fed would certainly have to put further rate cuts on hold. In fact, the Fed may well feel the need to raise rates again," Krugman wrote.

The minutes of the Fed's December policy meeting echoed what Fed Chairman Powell said at the time. The newly released minutes said that "almost all Fed officials saw that the risks to the upside of inflation were increasing, in part because the incoming Trump administration is considering potential adjustments to trade and immigration policies." However, these concerns did not stop the Fed from cutting interest rates by 25 basis points last month.

Earlier Wednesday, economist Adam Posen, a monetary policy expert who previously served on the Bank of England's rate-setting committee, said he thought the Fed would have to start raising rates this summer in response to Trump's budget plans.

However, investors also heard from Fed Governor Waller on Wednesday, who expressed support for more rate cuts this year and disagreed that the import tariffs proposed by the incoming Trump administration would lead to sustained inflationary pressures.

Investors are not ready to attribute all of the rise in Treasury yields to unease caused by tariffs and other policies.

Krugman's article was also a response to a Tuesday article by Torsten Slok, chief economist at Apollo Global Management, who argued that the jump in the 10-year Treasury yield from around 3.6% in September to around 4.7% after the Fed cut was highly unusual.

"Is it fiscal concerns? Is it reduced foreign demand? Or are the Fed's rate cuts not justified? The market is telling us something, and it's important for investors to understand why long-term rates are rising while the Fed is cutting," Slok wrote.

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

Meanwhile, whatever the reason for the rise, the surge in yields is the culprit for the post-election stock market rally, especially given the stretched valuations of technology stocks.

"I think the Greenland story is probably more entertaining than fundamental," Mark Hackett, head of investment research at Nationwide, said in a phone interview.

In contrast, concerns about tariffs are having an impact, he said, but he believes the stock market is "in a mode of looking for a reason to sell right now."

In other words, the market was "expensive and exhausted" after the S&P 500 posted its second straight year of 20%-plus annual gains, and the tariff jitters provided a fertile excuse for selling.

When it comes to rising yields, Krugman conceded that his preferred explanation "may be wishful thinking." The economist predicted an impending global recession when Trump was first elected president in November 2016, but walked back that call days later, warning that Trump's victory could ultimately have dire consequences but could help speed economic growth in the short term.

In Wednesday's article, Krugman said he didn't want to "push his argument too far," in part because "I don't want to succumb to motivated reasoning." "Those of us who are shocked by Trump's rise to power want to see him punished by the markets, but we shouldn't expect instant gratification," he said. "It will likely be years before the consequences of his economic delusions become truly apparent," he said.