Bond markets are reacting violently to tariff pause

by Ruth Carson and Alice Gledhill

Global bonds reacted violently to a turbulent day for US Treasuries, with markets rapidly unwinding bets on interest-rate cuts in the wake of US President Donald Trump’s surprise pause on tariffs.

The yield on the German two-year note soared nearly 20 basis points before paring as traders slashed wagers on the extent of easing expected from the European Central Bank. Those moves echoed gyrations in Asia, where short-end yields surged from Australia to Japan. US Treasuries meanwhile jumped after ending Wednesday sharply lower.

Trump’s about-face came roughly 13 hours after high duties on 56 nations and the European Union took effect, fueling market turmoil and stoking recession fears. The president faced massive pressure from business leaders and investors to reverse course; he said he backed off as people were “getting a little bit yippy, a little bit afraid.”

“The ‘blink’ came sooner than we expected, probably forced by the markets,” said Mohit Kumar, strategist at Jefferies International. “The reversal is in sharp contrast to the fanfare with which Trump unveiled his tariff policy just a week ago.”

That u-turn, via a 90-day pause on tariffs for most countries — with China being a notable exception, fueled an almost 10% rally in US stocks and a slide in two-year Treasuries that pushed yields up as much as 30 basis points. The shift however gave some respite to the US’s long-term borrowing costs, which had at one point surged above 5%. 

The government is due to auction 30-year debt on Thursday, hours after it publishes a report on inflation that could give traders more color on the Federal Reserve’s room to lower interest rates. The Consumer Price Index is seen easing to 2.5% from 2.8% by economists surveyed by Bloomberg. A metric that strips out food and energy is seen slowing to 3% from 3.1%.

Yields on US 10-year Treasuries fell five basis points to around 4.28% after jumping as much as 22 basis points on Wednesday. Two-year rates fell around seven basis points to 3.84%.

Money-market swaps now show the ECB easing about 76 basis points in total, roughly nine basis points less than at Wednesday’s close. Traders are pricing in a similar amount of rate cuts by the Bank of England.

The moves in European markets followed a volatile session in Asia. Australia’s three-year bond yields surged Thursday by the most since September 2022. New Zealand’s two-year yields jumped nine basis points. Japan was an outlier, with its longer-end bonds facing the most selling pressure: 10-year JGB yields rose 13 basis points to 1.40% at one point. 

“Bonds are signaling that the pause is significant, yet not much has fundamentally changed,” ING rates strategists led by Padhraic Garvey wrote in a note published Thursday. “Markets will not easily forget these episodes with wide market swings and thus the demand for safe assets should remain elevated.”

Traders are now bracing themselves for a period of prolonged negotiations that could weigh on markets for months.

The recent movements in the Treasuries market have fueled speculation among traders about who has been selling. Some investors are worried about a blow-up of the basis trade, where hedge funds profit from the difference between futures and spot prices, others about an implosion of trades in Treasury swaps. Another theory is that central banks are cutting their holdings of Treasury bonds.

And amid the on-again, off-again whiplash of Trump’s tariffs, investors are facing the increasingly complicated task of trying to figure out how shifts in global trade will impact the twin levers of growth and inflation — both important drivers of rate expectations.

“This period of instability will continue for the next couple of weeks,” said Tsutomu Soma, a bond trader at Monex Inc. in Tokyo. “No one knows what shape these tariffs are ultimately going to take and everyone’s looking at US yields to trade — so brace for more chaos ahead.”

Copyright Bloomberg News