Executive Summary:
Long-term Treasury bond yields surged last week despite news that March inflation was subdued and consumer sentiment is falling fast. That’s partly because the federal budget deficit is too d@mn high! In the past, recessions and lower long-term bond yields were associated with higher deficits; but the budget deficit has been widening since Covid despite a growing economy. Supply of long-term bonds also affects yields, but less so since the Treasury Department started issuing more short-term debt in 2023. Observers have been perplexed by the rise in long-term yields, but the reason for it may simply be that global demand for US Treasury bonds has shriveled, as Trump’s Tariff Turmoil is raising inflationary expectations. … Check out the accompanying chart collection.
Bonds I: Kerfuffle.
Bloomberg reported that JPMorgan Chase & Co. CEO Jamie Dimon said on the company’s Friday earnings call: “There will be a kerfuffle in the Treasury markets because of all the rules and regulations. When that happens, the Fed will step in—but not until ‘they start to panic a little bit.’ He added, ‘When you have a lot of volatile markets and very wide spreads and low liquidity in Treasuries, it affects all other capital markets. That’s the reason to do it, not as a favor to the banks.’”
There has already been a kerfuffle in the bond market since April 2, i.e., on President Donald Trump’s self-proclaimed “Liberation Day,” when he announced higher-than-expected reciprocal tariffs on 60 countries, including an island populated only by penguins. The tariffs were scheduled to take effect on April 9, when they were postponed for 90 days because of the bond market’s kerfuffle. The tariffs on China, however, were implemented. The 25% tariff on aluminum, steel, and autos remained in place.
Trump acknowledged that he postponed the tariffs because of the bond market’s kerfuffle. The 10-year Treasury bond yield did fall slightly during April 3 and April 4 to 4.01%. But then it climbed to 4.49% on Friday, April 11. That happened despite lower-than-expected March Consumer Price Index (CPI) and Producer Price Index (PPI) readings on April 10 and April 11. Even the sharp drop in consumer sentiment during the first two weeks of April (reported on April 11) didn’t stop the bond yield from moving higher, as it would have in normal times.
The problem is that Trump’s Tariff Turmoil (TTT) is expected to be inflationary, as evidenced by the big jump in consumers’ inflationary expectations during the first two weeks of April. This means that rising inflation likely would delay any Fed easing to avert a recession. Fed officials aren’t about to lower the federal funds rate (FFR) anytime soon, as they have been saying since the beginning of the year. In an April 4 speech, Fed Chair Jerome Powell suggested that they’re in even less of a hurry to do so now than before TTT, since the tariffs turned out to be higher than widely expected:
“While uncertainty remains elevated, it is now becoming clear that the tariff increases will be significantly larger than expected. The same is likely to be true of the economic effects, which will include higher inflation and slower growth. The size and duration of these effects remain uncertain. While tariffs are highly likely to generate at least a temporary rise in inflation, it is also possible that the effects could be more persistent. Avoiding that outcome would depend on keeping longer-term inflation expectations well anchored, on the size of the effects, and on how long it takes for them to pass through fully to prices. Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem.”
So bond investors may be in no rush to buy bonds, especially since they may not be convinced that Washington will do enough to reduce the federal deficit.
On Friday and Saturday, Trump continued to back off from his tariffs, which he has described as “a beautiful thing.”
Bonds II: The Yellen/Bessent Short-Term Solution to Debt.
I have been on Wall Street for more than 45 years. Over that period, there has been a lot of concern about mounting federal deficits and debt. Along the way, some of us bond market watchers observed that bond yields tended to decline when federal budget deficits widened during recessions; that’s because recessions caused the federal government’s revenues to decline, as Americans’ incomes and profits fell, and the government’s outlays to be boosted by its income support programs. Deficits were mostly counter-cyclical, widening during recessions and narrowing during expansions.
▌View Related Live Charts: US - Federal Surplus Or Deficit
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No big deal.
Yet starting in the 1980s, there were mounting concerns that federal government debt was ...
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