Here we go again. Toddler throws tariff tantrum again, and then some. I’d say “Happy Friday” but our screens have just puked up a headline about 50% tariffs hitting Europe within the next week. Clearly, the crypto-corruption-fest dinner last night in Virginia didn’t lighten Agent Orange’s mood. Indeed, in the past few hours we have also seen Harvard’s entire international student programme blown up by a planned White House denial of education visas and Apple have been threatened with 25% tariffs on foreign manufactured iPhones. Only a few weeks ago commentators were flagging that trade policy had already changed more than 50 times since Trump 2.0 entered office, rather than a prison cell. One could despair, or even ignore the headlines, but in the bowels of the financial system something is stirring. At first, you’ll be alarmed but there might be an optimistic twist to follow. First, let’s look at the finance stuff.
The global tail wagging the dog (or DOGE) is the bond market. Specifically, investors in US bonds (Treasuries) are worried about a now centrally-controlled economy run by a fella who almost uniquely bankrupted a casino. There were two events this week which signalled increased investor nerves about US debt and Washington’s ability to rein in its budget deficit. The catalyst was the passing of Trump’s “Big Beautiful Bill” by one vote in the House of Representatives which was a mix of spending cuts for poorer Americans and tax cuts for the rich. Economist, Robert Reich, estimates the have-nots will lose $700-$1000 of benefits (including Medicaid) while the have-yachts in the top 0.1% of US society will pocket an extra $390,000 per year. Sounds ugly, but the bond market is clearly not buying the thesis that making oligarchs richer will benefit the nation overall. Nope, investors in US Treasuries expressed their concern in two ways:
- US Bonds of longer maturities (20-year and 30-year Treasuries) were sold by foreign investors which resulted in the yields(rates) on those bonds rising. In simple terms, when a bond falls in price, its yield or rate of interest rises to hopefully attract new buyers.
- A regular auction of 20-year bonds conducted by the US Treasury was received poorly and forced the Treasury to offer higher yields to attract sufficient investor interest.
The blunt impact of these events is that US bonds are becoming less attractive for investors and so they are demanding higher yields (interest rates) to compensate for the risk of policy lunacy in Washington. Think Liz Truss and lettuce economics and then put on your helmet. The undermining of the credibility of the US bond market is a far bigger deal than turbulence in the British bond markets. The critical point about US bonds is that they are the source of the primary building block in every debt or investment calculation around the world. You will see it referenced as the “risk-free rate” of interest which makes the presumption that the US would never default on its debt obligations. Did anyone say bull…..??? Well, the whole world is beginning to wonder is the next toddler tantrum going to be the stiffing of a sovereign counterparty on a debt repayment. And the casino cracker guy has form. However, it will be US citizens who suffer monetarily first.
The price of mortgages, auto financing, insurance, credit cards, BNPL rates will all rise as ‘risk-free’ interest rates rise. The scary thing is that the concept of “risk-free” returns on dollar denominated debt being trashed will impact the entire financial system and the calculations of everything from M&A deals to commodity prices. Hopefully, this might spook the right people in Washington, including the 100 Senators who must vote on the “Big Beautiful Bill” too. There are potentially a few other things that might catch their eye.
Firstly, credit default swaps (CDS) which this country became familiar with prior to Troika/IMF intervention can measure a sovereign state’s risk of default. Right now, the financial markets (through these CDS instruments) are pricing US default risk higher than…. Greece. Second, somebody might spot a little flaw in the MAGA make- everything-in-America dogma. Sure, the US has trade deficits on goods. But, what about services surpluses? More importantly, and a critical input into all GDP calculations, is foreign investment in US assets. We have written recently on Japan’s position as the world’s biggest creditor/investor in foreign assets. But, do you know the country which has the world’s worst, or most negative, net international investment position…? According to research by Deutsche Bank, that would be the good ol’ USA in the chart at the end of this article.
Finally, as institutional vandalism is in full swing in Washington, the rest of the world is hoping the independence of the Federal Reserve (the Fed), and its Chairman Jay Powell, can be preserved. Again, there is breaking news and it’s not so good. The US Supreme Court overnight has decided that it is comfortable with the idea of independent government agencies (like the FTC, FCC, EPA etc) being abandoned. Instead, the right-wing constructed court has embraced the idea of a “unitary executive” which means Trump gains control over these agencies. However, the majority decision of the court stated that the Fed was not covered by this judgment. For now. There is perhaps a wider perspective than Fed independence. If US rule of law is under threat, that will ultimately feed into US bond market weakness. Bonds are, in effect, a legal contract between the USA and investors. And, I’m quietly hopeful international bond market investors are going to be bullying quite a few US Senators before they vote…..and understand the impact of the chart below.
