Post-Liberation Day fallout was primarily fixated on equity markets, as individuals and corporations around the world watched their wealth evaporate, day after brutal trading day. But the sell-off was presumably a calculated risk on the part of the Trump administration, the cost of administering its bitter pill to cure an ailing US economy. Moreover, US equity markets in particular had been riding the highs of a multi-year bull market. This created some space for a controlled correction, so the logic goes.
But where the Trump administration evidently miscalculated was the reaction of bond markets. Here the presumption was that investors fleeing the bloodletting in equities would seek safety in US Treasuries, in line with conventional logic, creating favorable borrowing terms for the US government in the process. And this is exactly what they did – at first. Then something unforeseen happened: investors began dumping US bonds en masse and yields began to tick upward. It was this reversal in bond markets that led Trump to change his mind, reportedly at the combined urging of Commerce Secretary Lutnick and Treasury Secretary Bassent.
These events put a spotlight on bond markets as a determining factor in the trade war. Once believed to be exceptional in this regard, the US economy got a small taste of the kind of capital upheaval that is typical of the developing world (and increasingly the developed as well). The episode will reverberate not just in what Trump is able to achieve with his trade policy, but also in how the wider global economy transitions away from the era of US primacy.
The Bond Market Stakes
Upward movement in US Treasury yields is a serious concern for US policymakers because the government remains highly reliant on external financing to fund itself. Washington registered a $1.3 trillion deficit over a six-month period from October to March – the second-highest on record (behind the 2021 COVID deficit). Long predicted by the Congressional Budget Office (CBO), interest payments are now seriously eroding the (already relatively small) pool of finance that the government gets to work with in its discretionary budget. These interest payments are expected to hit $1 trillion by 2026, hovering at approximately 4.7% of GDP in 2024. Ongoing deficit spending is also adding to the mountain of government debt, which stands at around 123% of GDP according to 2024 numbers from the White House Office of Management and Budget.
