We Finally Found the One Thing Trump Can't Bully: The Bond Market

 

For anyone with a 401(k) account, the last week has been a roller coaster.  Stocks plummeted after Trump announced the largest tariff increase in American history, only to have the market see huge gains after the tariffs were paused.  Apparently, the fact that this was just a pause and still applies to our largest trading partner--and thus the Trump tariff chaos will continue--has resulted in yet another sell-off today.

But the stock market is not where you should focus.  By all accounts, it was not the stock market that caused Trump to pull back from his tariffs--it was the bond market.

James Carville famously said "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."  

You would expect that when stocks are falling investors would flee to the safer Treasury Bond market.  That is what usually happens when stocks are falling and there are fears of a recession.  But that is not what happened.  Instead, after an initial drop,  the 10 year Treasury  Bond rate
jumped a full quarter point.  As the Guardian reported, "'This is a fire sale of Treasuries,” said Calvin Yeoh, a portfolio manager at the hedge fund Blue Edge Advisors. “I haven’t seen moves or volatility of this size since the chaos of the pandemic in 2020.'"

This means that investors ere less likely to view Treasury bonds as a safe place to put their money.  This should not have been a surprise--fully a third of all Treasury holdings are by foreign institutions--and even a small sale of these bonds can cause a large increase in interest rates.  Gordon Ip (one of my favorite financial columnists) explained this today in the Wall Street Journal:

As of last June, foreigners held $7 trillion of Treasury bonds (half by official investors such as central banks). That is about a third of the total held by the public. The federal budget deficit is running at around $2 trillion a year, or 7% of gross domestic product, and Senate Republicans just passed a budget resolution that would continue outsize deficits for the foreseeable future.

So the U.S. needs foreigners to keep rolling over the bonds they hold, and buying new ones. Even a small pullback would cause yields to jump. Jay Barry, head of global rates strategy at JPMorgan Chase, estimates that yields rise a third of percentage point for each $300 billion decline in foreign official holdings of Treasurys.

So why was this so scary to Trump that he pulled back--at least for 90 days--from the huge tariff increase? The concern is that the sell-off of the Treasurys could become a rout, resulting in huge increases in interest rates--which could have a devastating effect on the U.S. economy.  Already high mortgage rates skyrocket.  Of greater concern is that a sell-off could threaten the U.S. financial system.  Banks use bonds as part of their capital reserves.  As the bond prices drop, their capital reserves do as well.  As we saw in 2008, a large drop in bank capital can cause the financial markets to "freeze"--they stop making loans.

The long and the short of all of this is that Trump finally ran into an institution he cannot bully: the bond market.   

My other posts of the Trump Tariffs:

Are the Trump Tariffs even Legal?

A Few Observations About the Trump Tariffs