The Trump administration has often complained of the “exorbitant burden” of having the world’s reserve currency — the dollar — and the world’s reserve asset — US Treasury bonds. Trump’s shock-and-awe tariff policy is now removing this burden at lightning speed, with fire sales of dollar assets threatening to unmoor the global financial system from its US anchor.
Investors, led by highly leveraged hedge funds, are dumping US government bonds, stocks and the dollar at a speed that has little precedent. The synchronised selling is reminiscent of the “moron premium” frenzy that engulfed the pound and gilts — UK government bonds — in the wake of Liz Truss’s mini-budget, but this time with far bigger consequences for the world economy.
Trump’s tariff-induced financial contagion has spread from the stock market, which recorded precipitous declines after the April 2 tariff announcement, to the US government bond market. The Treasury market is the most important in the world, underwriting the global financial system and usually the safest place to put your money in times of mass uncertainty.
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This is no longer the case. Traders, money managers and hedge funds are rushing out of US bonds, triggering the biggest three-day jump in 30-year Treasury yields in more than 40 years. For bonds, yields rise as prices fall.
“Something has broken tonight in the bond market,” Jim Bianco, market strategist at Bianco research, said. “This kind of historic move is caused by a forced liquidation, not human managers making decisions about the outlook for [interest] rates.”
Stock market declines are a problem for investors and can spill into the real economy. But bond market panic can dethrone governments — as Truss found out — and create broader financial storms if liquidity drains from the market and there is no “buyer of last resort” to step in to buy assets.
In the US case, markets are entering uncharted territory, with the world’s safest “risk-free” asset at the heart of the panic and with the president of the world’s largest economy defiantly pushing trade and fiscal policies that are deepening the sell-off.
Geopolitics and Trump’s aggression towards China and its trading partners also matter. So far, evidence suggests that highly leveraged hedge funds stung by the “basis trade” — where the aim is to profit on the price difference between bonds and futures contracts linked to them — and other domestic holders of US bonds are the main sellers of Treasury bonds. If China and Japan, the world’s two largest holders of US government debt, start dumping US bonds in retaliation for the tariffs, then the global trade war will morph into an all-out financial war.
“The next phase risks being an outright financial war involving Chinese ownership of US assets, both on the official and private sector front,” George Saravelos at Deutsche Bank said. “There can be no winner to such a war: it will damage both the owner — China — and the producer — the US — of those assets. The loser will be the global economy.”
Pressure is mounting on the US Federal Reserve to step in with emergency measures that flood the market with cheap dollars, and buy up 10-year to 30-year Treasury bonds — just as the Bank of England was forced to do in 2022. A quantitative easing intervention is more likely than an emergency interest rate cut as the central bank is facing down the risk of inflation taking flight once again as a result of Trump’s import taxes.
“The central bank can’t totally abandon its worries about inflation, especially after four years of missing its target. It doesn’t want to cut rates, but it can’t sit on its hands while markets break,” Dario Perkins at TS Lombard said.
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Investors are selling bonds over worries that rising inflation will force the Fed to keep monetary policy tight even as economic growth could crater. The dumping of longer-term yields is a bet against the future growth prospects of the US economy and the credibility of an administration which has raised trade protectionism to the highest level in more than a century. Since April 2, Trump’s officials have flooded the zone with contradictory messages about whether tariffs are here to stay or can easily be negotiated away.
“In any other country, this would be called a sovereign crisis,” Paul Diggle, chief economist at investment firm Aberdeen, said.
Financial markets are giving the White House the weaker dollar that Trump’s officials, such as Stephen Miran, chairman of the Council of Economic Advisers, have called for. Miran has complained about the world’s unending appetite for US assets, arguing this safe status has artificially inflated the value of the dollar, making US exports uncompetitive and hollowing out America’s manufacturing sector. The fact that foreign investors want to hold US government debt, lowering borrowing costs and funding the country’s 7 per cent of GDP deficit, has also been lamented by Trump’s acolytes as a financial distortion.
If a weaker dollar and higher borrowing costs are a marker of success for the Trump administration, then the White House will be in no rush to pull back on tariffs. In the intervening period, the US could lose its unchallenged status as a global financial hegemon.
