US Bond Market Warns of Inflation and Economic Slowdown Amidst Tariffs

The U.S. bond market is signaling concerns that President Trump's tariffs on major trading partners could lead to increased inflation and hamper economic growth.

Rising Short-Term Yields

Short-dated Treasury yields spiked by eight basis points on Monday, reaching 4.28%. This increase reflects expectations that tariffs will push up consumer prices and keep interest rates elevated.

Narrowing Yield Gap

However, longer-term yields moved in the opposite direction, indicating worries about economic stagnation. The gap between 2- and 30-year bond yields narrowed to its smallest since early December.

Stagflation Risk

Traders anticipate that the trade war will shock the economy, which has so far shown resilience. The threat of rising import prices rekindling inflation has lingered since Trump's election, dimming hopes for Federal Reserve rate cuts.

Fed on Hold

The central bank paused its monetary policy easing cycle in January, and futures markets expect rates to remain on hold until later this year. "Stagflation risks are elevated," said Jack McIntyre of Brandywine Global Investment Management.

Flattening Yield Curve

Goldman Sachs Group Inc. predicts a continuation of the bond market's current trend, leading to a flattened yield curve. BNP Paribas SA, DBS Bank, and SMBC Nikko Securities warn of the risk of stagflation in the U.S. economy.

Market Impact

The inclusion of gasoline and food in the tariffs could raise long-term inflation expectations, favoring 10-year inflation-linked Treasuries. BNP strategists believe the Fed will maintain rates while assessing the severity of growth and inflation pressures. If stagflation occurs, rate hikes are a possibility.

Haven Demand

Amidst the market turbulence, long-dated bonds are benefiting from demand for haven assets. "The market is pricing in higher inflation," said Kathy Jones of Charles Schwab. "If stocks continue to decline, the flight to safety will drive yield curve inversion."

Euro-Area Divergence

European bonds rallied in contrast to U.S. peers, reflecting a flight to safety. The German 2-year yield dropped to 2.05%, a significant spread of over 220 basis points below the U.S. equivalent.

Goldman Sachs Outlook

Goldman Sachs anticipates that the Fed will prioritize inflation containment over growth stimulation, flattening the yield curve as markets price in a more hawkish outlook.