The White House may shrug off any fallout from the simmering transatlantic trade war on U.S. stocks or even the dollar, but a surge in U.S. Treasury yields could prove especially toxic for Donald Trump’s administration in a mid-term election year.
Whether that would be enough to make the U.S. president back down – as some believe a Treasury yield spike did after the “Liberation Day” tariff salvo last April- is an open question, one that raises the stakes for investors in U.S. debt and for the administration itself.
Financial turbulence surrounding the initial Trump tariff sweep last spring subsided quickly. But global investors may have grown complacent in assuming that deals eventually get done, helped by the unwillingness of European allies to ruffle U.S. relations.
Tariff threats from Washington over U.S. demands to take over Denmark-ruled Greenland mean European leaders are fast realizing that capitulation on trade last year merely emboldened Trump to use the trade weapon again for more serious territorial and military objectives.
Already Europe has suspended trade talks that underpinned the original trade truce from last year and has retabled more than US$100-billion of frozen counter tariffs on U.S. goods if Trump goes ahead with his latest increase in import levies next month.
Washington’s “endless accumulation” of new tariffs is “fundamentally unacceptable,” French President Emmanuel Macron said in Davos, having already called for use of the European Union’s draconian “Anti-Coercion Instrument” on trade retaliation. “We do prefer rule of law to brutality.”
If European countries are now much less likely to buckle on tariffs again, markets will have to price in a potential escalation, with an endgame of tit-for-tat retaliation and possibly investment curbs or financial embargoes that call into question Europe’s gigantic holdings of U.S. stocks and bonds.
The first reaction on Monday was relatively calm given that Wall Street was closed for a holiday, even though the direction of declines in both U.S. and European stocks and the dollar was clear, as was the new jump in gold prices.
But as American markets reopened on Tuesday, there was a sharp jump in Treasury yields to their highest in four months.
The unusual sight of U.S. stocks, bond prices and the dollar falling in tandem re-ignited concerns about capital flight from richly-valued U.S. assets – not least due to the vulnerability of America’s still ballooning net international investment gap of almost US$28-trillion.
While that picture may be disturbing in itself, it’s the Treasury component that likely rankles most in Washington.
Stock markets grab most headlines, but they are at record highs and traditionally more volatile anyway. Stock gyrations may be more easily batted away by government officials, citing a myriad of other influences from bubble-like artificial intelligence and tech themes to earnings season sideswipes.
A fresh dollar decline is a possible red flag about the re-emergence of a “Sell America” trade – once again showing its decades-old safe haven status is compromised.
But this too can be deflected away, partly as it chimes with political pressure to get Federal Reserve interest rates lower, and mainly because the administration likely wants a cheaper dollar to aid its exports and its wider global trade reset.
Rising Treasury yields cause a whole different set of issues – further complicating the funding of mounting U.S. debt piles and torching Trump’s big housing “affordability” push ahead of November’s mid-term congressional elections.
The prospect of rising mortgage rates on the back of higher Treasury yields cuts across much of the president’s new-year economic agenda. After Tuesday’s jump, for example, 30-year U.S. Treasury yields are 10 basis points above where they were at Trump’s inauguration last year – despite three Fed rate cuts in the interim.
That comes as U.S. opinion polls show voters think Trump is spending too much time on world affairs and not enough on fixing the economy, let alone risking another import price rise with new tariffs.
“Toying with more tariffs won’t help,” wrote AXA Group chief economist Gilles Moec, adding that the eight European states targeted account for 25 per cent of U.S. imports and a 10-per-cent tariff rise would lift the average U.S. tariff rate by 2.5 percentage points.
While any direct European divestment of Treasuries may yet be a big catalyst – especially if it involved giant Nordic funds at the epicentre of the Greenland row, such as Norway’s $2 trillion sovereign fund – Treasuries are already navigating a host of domestic and global crosswinds.
Debt markets are on tenterhooks over the long-term inflation impact of Trump’s challenge to Fed independence as well as the price impact of ever higher tariffs. But the Supreme Court’s imminent ruling on Trump’s use of emergency powers for last year’s tariff hikes could also cut Treasury revenues for a period if they are struck down and trigger a wave of rebates.
What’s more, Tuesday’s jump in Treasury yields was amplified by Japan’s decision to call a snap election next month, which catapulted Japanese long-term debt yields sharply higher on fears of a new mandate for big fiscal spending, rippling across sovereign bond markets worldwide.
Trump seems to feel confident he can ratchet up his domestic economic and geopolitical agendas tenfold this year. The precarious position of U.S. debt markets may yet be one of the few things that could cool his engines.
