Obama Vs. the Bond Market

Will deficit spending send interest rates higher?


Barack Obama has no intention of trying to balance the budget anytime soon. Here is what he will try to do (and this is straight from Team Obama): "Obama's plan pays for all proposals and cuts the deficit from its 2008 level and relative to what would happen if current policies were continued. He would like to balance the budget but with the tremendous economic and global uncertainty cannot make a specific promise about when that will happen."

In other words, 1) Obama's projections assume the Bush tax cuts don't expire even though they do at the end of 2010; 2) Obama isn't going to pull a Clinton and sacrifice his "investment agenda" to please budget hawks and the bond market. (And let me add a third point: I think Obama believes getting entitlements under control is more important than annual budget deficits. Just a guess.)

So what will bond investors think, since they kinda-sorta have an impact on interest rates? Greg Valliere of the Stanford Group recently made the following point to me: "Obama is going to be totally hamstrung by the deficit.... I am shocked about how oblivious people are to the budget deficit."

While Obama's folks are talking about a deficit goal that is about 2.5 percent of gross domestic product or lower for the first term, Valliere thinks Uncle Sam will be running deficits that are 3 percent of GDP or higher in coming years. (We have not consistently run deficits at those levels since the early 1990s.) And if that ratio starts approaching 4 percent ($500 billion banking bailout, anyone?), "the bond market will send a nasty message."

Keep in mind that Obama advisers like Jason Furman and Austan Goolsbee (and the centrist Tax Policy Center) maintain that deficits will be far larger under McCain. More on that to come....