Trump dodged a disaster from the bond market

KEY POINTS

• President Donald Trump’s stunning tariff pivot Wednesday followed massive tumult in the $140 trillion global bond market and particularly in the $47 trillion portion involving U.S. fixed income.
• “If he wasn’t paying attention to the stock market, now we know he’s paying attention to the bond market,” said market veteran Ed Yardeni.
• Though some White House officials, such as Treasury Secretary Scott Bessent, insisted that the move to delay the additional tariffs was the plan all along, the bond market made the decision easier.

• The bond market screamed at President?Donald Trump?this week to change course on his tariff plans before he eventually listened and potentially avoided a catastrophe.

  Trump’s?stunning pivot Wednesdayfollowed massive tumult in the $140 trillion global bond market and particularly in the $47 trillion portion involving U.S. fixed income.

• As speculation grew that the ominous surge in Treasury yields was about to create a domino effect of problems for financial markets, the president capitulated. That led to a breathtaking fury on Wall Street, with major stock market averages staging a historic rally and bond yields coming off their highs.

  But with equities plunging again Thursday, questions remain over market stability, as the course ahead is anything but certain, particularly considering the?chaotic events of the past week?or so.

  “What happened yesterday was the market cheered that the ‘Trump put’ was back,” said Ed Yardeni, head of Yardeni Research. “If he wasn’t paying attention to the stock market, now we know he’s paying attention to the bond market.”

  The bond market’s message was straightforward even if the underlying rationale was complicated.

  The message was that the tumultuous and inscrutable rollout of the Trump tariffs had instilled far more uncertainty than fixed income investors were willing to tolerate. In turn, some of those investors turned into “bond vigilantes,” demanding higher yields as compensation for the risks they were being asked to take in the normally risk-free highly liquid U.S. Treasury market.The 10-year yield was slightly lower Thursday but still about 37 basis points, or 0.37 percentage point, above where it started the week.

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  The ‘origin of the shock’

  The move in Treasurys, the world’s most liquid market where more than $1 trillion changes hands each day, came at a time when?the administration’s stated goal?is to lower yields to bring down borrowing costs. All manner of debt, from mortgages to credit card balances to auto loans, is priced off 10-year note yields.

  “The origin of the shock was the inept rollout of the trade regime,” said Joseph Brusuelas, chief economist at tax consultancy RSM. “There’s been a loss of credibility and confidence in the US regime and behavior across financial markets reflects that.”

  Market insiders attribute the bond market blowup, with higher yields both reflecting fear and leading to dislocations on a number of fronts, to a number of factors: the unwinding of a complicated but popular trade involving interest rate-based products; the fiscal train wreck in Washington that is sapping investor confidence; and the need for hedge funds to raise cash for operating income and to cover margin calls.

  In an interview with CNN International, former Treasury Secretary Janet Yellen said Thursday that “highly leveraged hedge funds” had to sell, causing further instability.

  Though some White House officials, such as Treasury Secretary Scott Bessent, insisted that the move to delay the additional tariffs was the plan all along, the bond market made the decision easier.

  “The fact that the bond market was telling us, ‘Hey, it’s probably time to move,’ certainly would have contributed at least a little bit to that thinking,” Kevin Hassett, director of Trump’s National Economic Council, told CNBC in an interview Thursday. “But it wasn’t the bond market that made a panic move, because there was a very systematic, well-planned move that was just about to happen that just turned out to be the same time.”

  Indeed, earlier in the day Wednesday Bessent told Fox Business that the bond market rout was merely “an uncomfortable but normal deleveraging” that wasn’t causing worry.

  However, JPMorgan Chase CEO?Jamie Dimon?followed Bessent, raising eyebrows when he said?a recession probably was imminent?that increased the stakes for action.

  Trump himself acknowledged that markets were acting “yippy” ahead of the policy switch.

  The root of the problem

  Issues causing the jump in yields were multipronged but all related to dislocations brought on by the swiftest three-day rise in Treasury yields since 2001.

  Among them were the unwinding of a popular trade that involves swapping floating-rate products such as Treasurys for a futures product, say the Federal Reserve’s Secured Overnight Financing Rate.

  Traders look to pocket the difference between the rates in what is known as the “basis swaps” trade. When Treasury yields rise, that tends to close the gap and reduce profit opportunities or cause losses. The situation is complicated when hedge funds use leverage for the trades, leading to margin calls and the need for quick cash, which is often obtained by selling government debt.

  “Right now, the unwinding of the basis swaps trade is the primary reason, but not the sole source, of the increase in yields across the Treasury curve,” Brusuelas said. Funds “are having to raise prodigious quantities of cash that results in the selling of Treasurys.”

  There are still more potential reasons for the bond unwind.

  They stem from the?clumsy April 2 rollout, with the hefty duties applied using a formula that has raised questions less about the general need for tariffs and more about the method in which they are being applied.

  At the same time, the precarious fiscal situation in the U.S. adds to investor angst as the budget deficit careens on a pace to exceed $2 trillion this year. On top of that, there are?growing signs of stagflation, with economists across Wall Street knocking down estimates for growth while raising inflation forecasts.

  “That’s no joke,” Brusuelas said. “When something like that happens, you’re going to get a significant increase in financial stress. Until that abates, we have to assume that there are going to be further issues.”

  One of the more intriguing reasons also cited for the bond market sell-off is the administration’s efforts to knock down the trade deficit of roughly $800 billion.

  While the goal in reducing the deficit is to open up the market for U.S. goods and services, it also has a knock-on effect that can affect bond yields.

  When the U.S. is taking in a lower level of goods from other countries, that means it is circulating fewer dollars. That in turn means less cash to buy Treasurys, with the lower demand driving up the yield that investors demand. At the same time, there are questions rising about a buyers’ strike and the potential for China to offload some of the $760 billion it is holding in U.S. debt.

  “Japan and China, two of the largest holders of [Treasurys], have been scaling back their demand in recent years,” Meghan Swiber, U.S. rates director at Bank of America, said in a note to clients. “Tariffs and the prospect of a shrinking US trade deficit may mount foreign selling pressures medium term. However, foreign investors are unlikely the only seller driving recent price action.”

  Amid the ever-burgeoning U.S. debt load, other countries have gradually increased their holdings of Treasurys over the past year.

  However, the two biggest creditors, Japan and China, have cut back on their holdings by about $100 billion — a small chunk of the $8.5 trillion in total held by foreign nations but a move in the wrong direction.

  While the stock market gets all the headlines, cracks in the bond market, which is far larger than its equity counterpart, can be much more mean meaningful. Bonds have been acting up since September 2024, when the Federal Reserve enacted a half percentage point interest rate cut despite signs of stubborn inflation. Instead of falling, rates surged following the Fed cut, indicating further misgivings about policy.

  “The bond vigilantes don’t like what monetary policy is doing and they certainly don’t like what Trump is doing on the trade side,” Yardeni said. “They had something to brag about yesterday with the stock market, but you can’t say the same thing with the bond market. Bonds are still acting twitchy.”

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