The US Treasury market experienced a slight pullback on Wednesday, with yields edging higher across the curve. This followed a period of significant gains driven by speculation that President Trump might adopt a less aggressive stance on tariffs. A 20-year bond auction brought the focus back to Treasury supply. The 10-year Treasury yield rose 3.5 basis points to 4.61%, after reaching as high as 4.81% last week.
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Tariff Concerns Ease, Driving Yield Retreat
The recent retreat in yields across the curve can be attributed to two key factors: softer US inflation data and President Trump’s decision to delay immediate implementation of import levies. These developments have alleviated concerns about a potential trade war that could reignite inflationary pressures. Market participants had previously priced in a more hawkish approach to tariffs, leading to higher yields.
Mark Nash, an investment manager at Jupiter Asset Management, noted the significant drop in long-end bond yields, stating that it “makes complete sense” given the shift in sentiment. He had begun purchasing 30-year US Treasuries prior to the inauguration, anticipating this potential outcome.
Trump’s Tariff Strategy: Bark Worse Than Bite?
While President Trump has broadened his tariff threats to include China and the European Union, in addition to Mexico and Canada, his only concrete action thus far has been to initiate a review of trade practices, due by April 1st. This provides trading partners with nearly 10 weeks to negotiate and potentially avert new tariffs.
Kathleen Brooks, research director at XTB, suggested that investors might be concluding that “Trump’s bark is worse than his bite when it comes to tariffs.” She also noted that the EU might be anticipating a less stringent “tariff light” approach from the US. Trump’s latest threat of a 10% tax on Chinese exports is considerably lower than the 60% he previously considered.
Inflation Expectations and Volatility Subside
As a result of the easing tariff concerns, measures of expected inflation, such as breakeven rates and swaps, have declined. Furthermore, a gauge of future volatility in the rates market has fallen from a seven-week high. President Trump’s efforts to reduce energy prices by promoting domestic oil and gas production have also contributed to this trend. While the December Consumer Price Index (CPI) remained above the Federal Reserve’s 2.9% target, the core CPI, excluding food and energy, showed moderation.
Nash commented that these policies “will help contain domestic inflation in the US,” adding that the administration is likely wary of escalating the cost of living due to potential voter backlash.
Continued Volatility Expected as Tariff Policies Evolve
Despite the recent calm, market participants anticipate further price fluctuations as President Trump refines his tariff policies. Justin Onuekwusi, chief investment officer at St. James’s Place, who increased his US Treasury holdings last year, is awaiting more pronounced market movements before adding further to his position. He cautioned that “it is very early days and the rhetoric hasn’t stopped,” emphasizing that the situation is far from resolved and continued volatility in the Treasury market is likely. Bloomberg strategists concur, suggesting that rates will likely remain range-bound until a formal tariff announcement is made.
Strong Demand at 20-Year Bond Auction
Even with the slight uptick in yields, a $13 billion sale of 20-year bonds attracted strong investor demand, with the yield coming in approximately one basis point below pre-auction levels. This robust appetite for US Treasuries was mirrored in Europe, where the UK, France, and Spain all witnessed record orders for their bond sales this week. Michael Leister, head of interest rates strategy at Commerzbank, observed that “markets seem comfortable,” indicating that neither Trump’s actions nor the increased supply of bonds have deviated significantly from prior expectations.
Looking Ahead to the Fed
In anticipation of the Federal Reserve’s upcoming policy meeting next week, traders are currently pricing in just one quarter-point interest rate cut this year, most likely in the second half. The market will be closely watching for any signals from the Fed regarding its assessment of the economic outlook and the potential impact of trade policy on future monetary policy decisions.
