President Donald Trump’s initiative to increase tariffs has brought significant volatility to the bond market. When the announcement of high tariffs on imports from numerous countries was made, many economists revised their forecasts for U.S. GDP growth downward. Concurrently, traders increased their speculation that the Federal Reserve would cut interest rates, anticipating that tariffs could slow the U.S. economy and possibly lead to a recession.
Typically, in such scenarios, Treasury bond prices increase, resulting in lowered yields, as bond market movements often reflect investor expectations regarding economic growth and interest rate trends. Investors usually gravitate towards safe assets when concerned about economic downturns. Generally, declining stock prices due to fears about slowing growth lead to rising bond prices.
However, under these turbulent market conditions, longer-term yields have not mirrored their expected patterns. Initially, Treasury yields dropped sharply amid the tariff announcements, but recently, they have risen significantly, with the 10-year U.S. Treasury yield nearing 4.5%. Even after Trump implemented a 90-day pause on most tariffs, excluding those on China, the 10-year Treasury yield stood at 4.35% as of Thursday.
This raises the question of whether investors should steer clear of longer-term U.S. Treasury notes and bonds at present.
In this context, long-term Treasury yields are influenced by the Federal Reserve’s benchmark federal funds rate but are primarily driven by market expectations. Treasury yields have been a focal point for several years, especially as bond investors focus on the U.S. debt situation. The federal government reported a deficit exceeding $1.8 trillion for fiscal 2024, with total debt surpassing $36 trillion.
Several factors contributed to the surge in Treasury yields during the tariff upheaval, none of which are particularly favorable for the economy or stock market. While higher yields could indicate confidence in economic growth, traders have been wagering on potential Fed interest rate cuts. Currently, options traders generally expect three quarter-point rate cuts this year, although these forecasts frequently change.
Federal Reserve Chair Jerome Powell has clarified that he is unlikely to cut rates in a robust economy, particularly with inflation remaining above the Fed’s 2% target. Thus, any rate cuts would likely be intended to support a weakening U.S. economy or prevent a potential recession.
Another factor influencing the rise in longer-term yields, like those on 10-year and 30-year U.S. Treasuries, is inflation expectations. Economists generally consider tariffs inflationary. Powell previously indicated that tariff-induced inflation would be temporary, but after Trump imposed steeper tariffs than anticipated, he warned that the inflationary impact could be more enduring. Higher Treasury yields as a response to inflation would be concerning.
Moreover, the growth of longer-term yields could be related to the nation’s debt situation. The U.S. Treasury Department reports about $6.15 trillion in Treasury debt maturing by March 19, 2026. Approximately a quarter of U.S. debt is held by foreign investors, according to Federal Reserve data. Increasing tensions with major U.S. debt buyers, particularly China, could affect their willingness to purchase U.S. Treasuries. If substantial quantities of bonds are sold, the increased supply could lower prices and raise yields.
Billionaire investor Jeffrey Gundlach, founder and co-CEO of DoubleLine Capital, stated on CNBC that ongoing conflicts with other countries could deter them from buying U.S. debt. He also predicted that a recession, leading to reduced revenue, could expand the U.S. fiscal deficit to $3 trillion. Gundlach anticipates higher Treasury yields in the next recession and recommends avoiding longer-term bonds, advising investment in two-, three-, and five-year U.S. Treasury notes.
Historically viewed as a safe haven, U.S. Treasuries now present increased risk due to the country’s growing debt, which raises the remote possibility of the government being unable to fulfill its debt obligations. As interest payments consume a larger portion of the budget, bond investors might demand higher returns to compensate for perceived risks, thereby raising yields. Moody’s has highlighted fiscal concerns and analysts have not ruled out the possibility of the agency lowering the federal government’s credit rating, as Standard & Poor’s did in 2011.
Financial concerns can become self-fulfilling prophecies, with perceived risks deterring investors. The regional bank crisis in 2023 illustrated this when fears about bank solvency led account holders to withdraw funds, exacerbating the crisis.
In conclusion, all lending is contingent on confidence. Thus, while there is a remote possibility of issues with longer-term Treasuries if government debt remains unaddressed, it is likely that Washington will fulfill its obligations. However, the uncertainty surrounding a traditionally secure fixed-income asset may prompt investors to reconsider their positions.
