US Bond Markets Warn of Stagflation Risks from Trump's Tariffs

Background: Trump's Tariffs Amidst Global Trade Tensions

President Trump's imposition of tariffs on key trading partners has raised concerns in the US bond market. These tariffs, including those on Canada, Mexico, and China, threaten to escalate trade tensions and potentially harm the US economy.

Bond Market Signals Inflation and Growth Risks

As a result of these tariffs, short-term Treasury yields have risen, while longer-term rates remain stable, flattening the yield curve significantly. This trend is typically associated with stagflation, a scenario characterized by high inflation and low economic growth.

Reduced Federal Reserve Easing Expectations

Traders have reduced bets on aggressive interest rate cuts from the Federal Reserve this year. The probability of two quarter-point rate cuts has dropped from 90% on Friday to 50%, indicating market skepticism towards further monetary easing.

Stagflation Risks and Economic Impact

Economic analysts, including those at BNP Paribas, warn of the potential for stagflation to materialize due to Trump's trade policies. Goldman Sachs anticipates further curve flattening, increasing the likelihood of higher inflation and lower growth.

Inflationary Pressures and Policy Response

The inclusion of gasoline and food products in the tariffs suggests that long-term inflation expectations may rise. This could prompt the Fed to consider interest rate hikes later this year, even amidst weaker economic growth.

Divergence between US and Eurozone Bonds

In contrast to the US bond market, euro-area bonds have rallied significantly, reflecting a flight to safety. The spread between US and German two-year yields has widened to over 220 basis points, indicating a preference for eurozone assets.

Goldman Sachs Perspective and Fed Outlook

Goldman Sachs expects the Fed to prioritize inflation containment over growth promotion, leading to a more hawkish stance. This outcome could weigh on longer-term yields and further flatten the yield curve.

Treasury Refunding Announcement

On Wednesday, the Treasury Department will announce its first refunding under the Trump administration, providing further insights into market sentiment and the potential impact of ongoing trade tensions.