While United States President Donald Trump appeared indifferent to U.S. share markets' pain, bond yields ultimately forced him to pause tariffs. Dysfunction in the bond market, following the four-day Wall Street selloff, saw the U.S. benchmark 10-year bond rate climb to 4.5%.
Lost confidence
This signalled a loss of confidence in the U.S. that triggered a sell-off by global investors, with Japan and China bailing out of bonds.
In other words, foreign participants no longer perceive the U.S. as a welcoming haven to park their funds.
Rob Arnott, founder and chairman of Research Affiliates notes that Trump cares more about the 10-year Treasury than about the stock market, because so many things are tied to that benchmark.
For example, it’s a big factor in setting car loans, mortgage rates, credit card rates, and also determines the “base rate" companies pay on their crucial long-term borrowings.
Long-term tariff gains Vs. short-term fears
Ultimately, while Trump always expected to play the long game with tariff benefits, bond market action suggested the time was up on that jig.
It’s understood that foreign institutions, individuals, and sovereign funds collectively own a staggering $10 trillion, or around 33% of all U.S. Treasuries.
What this figure highlights is the degree to which the U.S. depends on foreign investors' conviction that America is the best place to have their savings.
What shouldn’t be underestimated noted Arnott of Research Affiliates is China’s potential power within the U.S. financial markets, courtesy of its huge holdings of U.S. Treasuries.
If they were big sellers, bond prices would tank, and yields (which move inversely to prices) would spike - a sure way to get under Trump’s skin.
“I think the Chinese government has read The Art of War, which has been Trump’s bible for life,” Arnott says.
“Gosh, you don’t think someone would want to play that card, do you?”
Why the worry?
So what are foreign investors concerned about when it comes to the U.S.?
Short answer, it’s the potential for an inflationary wave that will erase the “real” value of the stream of interest payments to come.
These are payments that when they buy 10-year Treasuries, are constant and locked in for a decade.
Assuming inflation rises, the big question is how the Federal Reserve (The Fed) will react.
Assuming The Fed chooses to sit and watch, John Cochrane, an economist at the Stanford Graduate School of Business sees a future where the consumer price index jumps up to 9%.
Under that scenario, interest rates would spike, and Trump’s beloved measure — 10-year yields — would keep climbing on fears that the Fed couldn't do the job. In addition, inflation could get even worse.
“If the rates on corporate bonds keep rising [so that interest payments sap their earnings], and companies can’t import cheap goods from China, a lot of businesses will go under,” says Cochrane.
Lingering bond investor fear
While the 10-year yield did move in the right direction in response to the Trump tariff pause - falling around eight basis points to 4.34% - that doesn’t mean investors now believe that big inflation has receded as a threat.
The lingering tariff overhang will be the litmus test for the U.S. as a cuddly residence for foreign funds.
For example, the 125% tariff on China remains and Trump still imposes a uniform duty of 10% on all U.S. trading partners.
Any plan by Trump to return to his original agenda may only ignite bond market fears.
With that 90-day fuse ticking down, SPI managing partner Stephen Innes believes there’s still a considerable amount of lingering risk.
“When treasuries stop acting like treasuries everything breaks,” said Innes.
“That’s when even the most tariff-hardline White House realises it is time to pump the brakes or risk a full-blown funding crisis.”
