By Davide Barbuscia

NEW YORK (Reuters) – A unified government under Donald Trump may provide investors with some relief from the contentious U.S. debt ceiling battles that have unsettled markets recently. However, this could lead to excessive fiscal expansion, potentially putting pressure on bonds in the long run.

According to Edison Research, when Trump takes office in January, the Republican Party is projected to control both houses of Congress. This "Red Sweep" grants the Trump administration more freedom to implement its economic agenda, including tax cuts and tariffs, which could spur growth but also heighten inflation and raise concerns about the U.S. budget deficit.

One-party control might streamline the process of agreeing on raising the debt ceiling—a cap on borrowing that requires a majority of lawmakers' approval. A debt ceiling crisis last year triggered a sell-off in stocks and bonds, nearly pushed the U.S. toward default, and negatively impacted the country's creditworthiness.

Jonathan Cohn, head of U.S. rates desk strategy at Nomura Securities International, commented, "It doesn't solve the fiscal sustainability questions going forward, but if the debt ceiling is less of a concern, it addresses immediate issues."

On November 6, 10-year Treasury yields reached their highest mark in over four months, indicating that investors were anticipating stronger growth, coupled with higher inflation and larger budget deficits after the Republican triumph in the election. Generally, yields increase when bond prices decline.

Post-election, the cost of insuring against U.S. government debt default saw a noticeable reduction. As per S&P Global Market Intelligence, spreads on U.S. one-year credit default swaps (CDS) fell to 18 basis points from 49 basis points on Election Day.

Thierry Wizman, global FX and rates strategist at Macquarie Group, noted, "The drop in U.S. sovereign CDS certainly reflects the lower risk of a debt ceiling crisis turning into a credit event, as long as the same party controls Congress and the Executive."

During last year’s negotiation, Democratic President Joe Biden collaborated with the Republican-controlled House to elevate the government’s $31.4 trillion borrowing limit, averting a historic default just two days before it could have occurred. However, the standoff led to a downgrade of the U.S. government's credit rating by Fitch and a negative outlook from Moody's, due in part to increasing political polarization hindering bipartisan agreements on fiscal reforms.

The debt ceiling will be reinstated on January 2. Analysts predict the Treasury may reach its X-date—when it can no longer meet its debt obligations—in the latter half of 2025.

JPMorgan strategists noted, "Last year's intense disputes are unlikely to recur given that the most contentious debates have occurred with a Democrat in the White House and Republicans controlling the House."

Despite the reduced likelihood of a repeat crisis, bond investors still face potential concerns. The anticipation of increased economic growth and inflation is already prompting some to reconsider their expectations for the depth of Federal Reserve interest rate cuts next year, impacting bonds negatively.

A unified government could exacerbate these worries. Recently, Moody's issued a warning about the rising risks to the nation's fiscal health, emphasizing that deficit growth could lead investors to demand higher premiums for U.S. debt. Naomi Fink, chief global strategist at Nikko Asset Management, stated, "The bond market may experience potential disruptions if external investors demand a higher premium to finance U.S. external deficits."