Donald Trump’s trade war has unsettled stock markets and increased concerns about a recession in both the US and Europe. However, these issues do not seem to be the primary reasons behind the president’s unexpected shift this week, during which he suspended most of his “liberation day” border taxes for a period of 90 days.
What is a bond?
A bond is a document verifying that the owner has lent a specific amount to a borrower, who agrees to repay it on a predetermined date, usually along with a fixed rate of interest. As fixed-income securities, bonds are appealing to investors seeking consistent returns.
Both corporations and governments issue bonds to raise capital – governments use them to fund investments and other expenditures. Bonds issued by the UK government are known as gilts, while those from the US government are referred to as treasuries, often considered a safe investment due to the backing of the world’s largest economy. These bonds have various maturity dates, with two-year, 10-year, and 30-year terms being common.
How are they traded?
Bonds can be traded similarly to stocks on exchanges, yet unlike stocks, they come with guaranteed returns each year. The bond market is the largest securities exchange globally, valued at nearly $130 trillion (£99 trillion), with the US market representing about 40% of the total debt worldwide.
Typically, government bonds are auctioned to financial institutions and can later be resold on the secondary market at values above or below their face value.
What is a bond yield?
Bond yields indicate the return an investor earns for holding the bond, calculated as a percentage of its current price. When a bond’s price decreases, the yield increases. This yield is often likened to an interest rate or the cost of borrowing for the issuer.
Increasing yields imply a declining interest among investors in the debt, influenced by various factors including the borrower’s repayment capability. For governments, this is tied to the health of the nation’s economy and financial stability.
Inflation expectations can also significantly affect yields, as inflation diminishes the future value of money earned from holding the debt. Consequently, investors may demand a higher yield to offset this risk.
Moreover, since other financial products, such as mortgages, are priced based on yield, there can be broader economic implications.
What have Trump’s tariffs done to bonds?
Initially, the US president believed his tariff policy was effective, as he expected negative reactions from stock markets and a devaluation of the dollar.
Trump was confident the bond market would remain stable, as he proposed utilizing tariff revenues to fund tax cuts later in the year, potentially allowing the US government to limit bond issuance and maintain a balanced supply-demand dynamic, capping overall public debt levels.
However, the trade war has incited fears of a US recession, increasing the risk associated with lending to the US. Concerns have arisen that prolonged conflict with China could severely impact both economies and lead to slower global growth.
Consequently, investors have significantly sold off US bonds, decreasing their value and driving up yields, which makes future government borrowing costlier.
Where did this leave Trump?
There were concerns within the White House that higher interest rates on national debt would exacerbate the government’s annual spending deficit, putting additional strain on an already stretched budget and increasing total debt levels.
Furthermore, the \$29 trillion market in US treasuries is fundamental to the global financial framework; excessive selling could destabilize various sectors, potentially leading to defaults by banks or other institutions and triggering a broader financial crisis.
Has the situation eased?
Following the US president’s announcement to suspend punitive tariffs on all countries except China for 90 days, the bond markets began to stabilize. Nevertheless, yields remain elevated, with the effective interest rate on a 10-year Treasury bond reaching 4.52% on Friday, up from 3.99% on April 4.
Is this Trump’s Liz Truss moment?
The UK’s brief prime minister, Liz Truss, was removed from office due to her contentious interactions with the bond markets, which deemed her mini-budget irresponsible. This verdict caused UK gilt yields to surge as bond values plummeted, leading mortgage providers to raise borrowing rates and undermining Truss’s government.
Although Trump has more resources at his disposal, he faces comparable apprehensions about the broader economic effects. If his policies indeed elevate inflation as predicted, with some analysts indicating a rate of 4.5% by next year, that could alienate the Republican base that initially supported him based on vows to reduce increasing food costs. If voters perceive tariffs as a tax on mortgages due to rising lending rates, it might adversely affect his popularity among his core supporters.
