(Bloomberg) — US bond markets are flashing a warning to US President Donald Trump that his move to unleash tariffs on top trading partners risks fueling inflation and stymieing growth.
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Short-end Treasury yields rose as much as eight basis points to 4.28% on Monday as longer-dated rates held steady, flattening the curve by the most since November.
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Such moves are typically associated with stagflation — when inflation and elevated interest rates harm bonds in the short term, only for subsequently weaker growth to make longer-term debt more appealing.
Traders have pared bets on the extent of easing from the Federal Reserve this year and now see a 50% chance of two quarter-point rate cuts this year, down from 90% on Friday.
Over the weekend, Trump followed through on his threat to impose levies on the exports of Canada, Mexico and China, while reiterating a warning to the European Union that tariffs “will definitely happen.” Goldman Sachs Group Inc. is positioning for further curve flattening, and firms including BNP Paribas SA, Singapore’s DBS Bank Ltd. and Japan’s SMBC Nikko Securities Inc. said this puts the US economy at risk of falling into stagflation.
“Trump’s policy mix has increased stagflationary risks in the economy,” Calvin Tse, head of Americas macro strategy and US economics at BNP in New York, wrote in a note. That implies the Fed will keep rates on hold for the next couple of meetings while it judges whether growth or inflation risks are “more serious,” Tse added.
With gasoline and food not excluded from tariffs, the BNP strategists said long-term inflation expectations could keep rising, favoring 10-year inflation-linked Treasuries.
“If this does indeed materialize, we think that rate hikes become a real possibility from the Fed this year, even in the face of lower growth,” they added.
Euro-area bonds diverged sharply with US peers, rallying amid a broad flight to safety. The two-year German yield dropped eight basis points to 2.05%, more than 220 basis points lower than the US equivalent, the wides gap since late December.
“In terms of the strategic implications of this dramatic opening salvo on the trade war front, we would be firmly biased in favor of a wider Atlantic spread,” Rabobank strategists wrote in a note. They recommend positioning for that move via shorter-dated tenors given longer-dated Treasuries may gain on the view that trade frictions will weigh on future US growth.
Bond traders are sounding the alarm as the US yield curve continues to flatten, with some warning of a potential inflation shock on the horizon. The yield curve, which measures the difference between short-term and long-term bond yields, has been narrowing in recent months, a trend that is typically seen as a signal of economic uncertainty.
Traders are concerned that this flattening yield curve could be a precursor to rising inflation, as historically low interest rates and massive government stimulus measures have the potential to drive up prices. Inflation erodes the purchasing power of fixed-income investments like bonds, leading to lower returns for investors.
The warning from bond traders comes as the Federal Reserve continues to keep interest rates near zero and has signaled that it is willing to tolerate higher inflation in the short term. While some economists believe that any increase in inflation will be transitory, others fear that the combination of loose monetary policy and fiscal stimulus could lead to sustained inflationary pressures.
Investors are being urged to closely monitor the yield curve and be prepared for potential shifts in the market that could impact their investment portfolios. As the debate over inflation and interest rates continues to unfold, bond traders are advising caution and vigilance in navigating the uncertain economic landscape.
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- Inflation shock
- US yield curve
- Flattening yield curve
- Bond market
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