Bond traders are signaling a growing risk that the US economy may stall, as President Donald Trump’s policies, including trade disruptions and federal workforce cuts, raise concerns about slowing growth.
Expectations that Trump would stimulate economic expansion, thereby pushing Treasury yields higher, are being replaced by mounting fears of a downturn.
Just weeks ago, bond markets were optimistic about continued economic growth, but that sentiment has shifted. As of mid-February, bond traders have increasingly sought short-dated Treasuries, driving the two-year yield down sharply. This movement reflects expectations that the Federal Reserve may begin cutting interest rates as early as May in an effort to prevent economic deterioration.
Gennadiy Goldberg, head of US interest rate strategy at TD Securities, noted the dramatic change in market sentiment:
“The market’s gone from exuberance about growth to absolute despair.”
This shift represents an abrupt reversal from the optimism seen following the presidential election, when investors initially bet that Trump’s policies would lead to faster growth and inflation, a phenomenon dubbed the “Trump trade.”
Since February, however, the outlook has become clouded by policy uncertainties. The decline in Treasury yields has been driven by shorter-dated securities, resulting in a steeper yield curve. This typically signals investor expectations that the Fed may ease monetary policy to support growth.
A major factor in the changing outlook is Trump’s escalating trade war, which threatens to disrupt global supply chains and add inflationary pressure. The stock market experienced a selloff in response to concerns about the trade war, which worsened despite the president’s delay of tariff hikes on Mexico and Canada. Additionally, Trump’s efforts to reduce federal funding and cut the government workforce are adding to economic concerns.
Tracy Chen, a portfolio manager at Brandywine Global Investment Management, explained:
“Recession risk is definitely higher because of the sequence of Trump’s policies – tariffs first, tax cuts later.”
The bond market’s shift in sentiment was further highlighted by a divergence between US and European bond markets, which typically move in tandem. While German bond yields rose in response to increased defense spending, US Treasuries remained largely unaffected.
Despite the pessimistic sentiment in the bond market, there are still several uncertainties. While the Federal Reserve is expected to cut rates in response to economic pressures, the central bank has shown reluctance to ease policy immediately. On Friday, Fed Chair Jerome Powell stated that “the economy continues to be in a good place” despite the “elevated levels of uncertainty.”
Additionally, inflation continues to exert upward pressure on yields. The consumer price index report for February is expected to show an annual increase of 2.9%, still above the Fed’s 2% target. Meanwhile, signs of a cooling economy have emerged, with the Atlanta Fed’s GDPNow gauge predicting that US GDP may shrink in the first quarter. Job growth in February held steady, but other indicators suggest that the labor market is softening.
The future direction of the bond market will largely depend on how Trump’s policies evolve in the coming months. Treasury Secretary Scott Bessent acknowledged that there may be disruptions, but expressed confidence in the long-term outlook. In response to concerns about aggressive cost-cutting, Trump instructed his cabinet to use a “scalpel” instead of a “hatchet” for job reductions. Despite the market turbulence, Trump has delayed tariff increases on Mexico and Canada for a second time, though tariffs on China and other nations remain in place.
Brandywine’s Chen remarked on the shift in market sentiment, saying:
“Prior to this tariff war, the market thought tariffs were inflationary, and now people think they are recessionary.”
This marks a significant change in investor perception as the potential for a recession becomes a more prominent concern.
