Source: Jinshi Data

In light of Trump's chaotic tariffs and federal layoffs, bond traders are signaling that the risk of a stagnant U.S. economy is increasing.

In less than two months since Trump took office as president, speculation has been made that he would inject stimulus into the expansion of the U.S. economy and continue to put pressure on U.S. Treasury yields, but this speculation is quickly being left behind. Instead, traders have been buying short-term U.S. Treasuries, with two-year Treasury yields falling sharply since mid-February, and markets expect the Fed to resume interest rate cuts as early as June to prevent economic deterioration.

"Just a few weeks ago, we were asked whether we thought the U.S. economy would accelerate again and again - and now the word ‘recession’ is suddenly mentioned," said Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, referring to the risk of a recession. "The market has shifted from optimism about economic growth to total despair."

This change marks a sudden reversal in the U.S. Treasury market. The main driver of the U.S. Treasury market over the past few years has been the surprising resilience of the U.S. economy, even as overseas economic growth slows down. Investors initially bet that the outcome of the presidential election would only exacerbate the trend, and pushed up Treasury yields at the end of last year due to expectations of faster economic growth and rising inflation — a pillar of the so-called "Trump deal."

However, since mid-February, U.S. Treasury yields have begun to decline as new things bring great uncertainty to the economic outlook, with short-term bonds leading the decline, which steeps the yield curve, which usually occurs when investors expect the Fed to start easing its currencies to stimulate economic growth.

Short-term bond yields lead the decline

A key driver is the trade war that Trump is brewing, which is likely to bring another inflationary shock and disrupt global supply chains. Stocks suffered a sell-off last week, even after Trump once again postponed tariff hikes on Mexico and Canada. The freeze of federal funds and the dismissal of tens of thousands of staff also had negative impacts.

"The risk of a recession is certainly higher due to Trump's order of tariffs first and tax cuts later," said Tracy Chen, portfolio manager at Brandywine Global Investment Management.

Trump said on Sunday that the United StatesThe economy faces a “transitional period” in response to concerns about the risk of economic slowdown. During the Asian trading session on Monday, U.S. Treasury bond prices rose, and the benchmark 10-year Treasury bond yield fell below 4.27%.

The divergence between European and U.S. bond markets highlighted a shift in market sentiment last week. These two markets usually fluctuate simultaneously. However, when German bond yields soared as more defense spending to compensate for U.S. expectations of reduced U.S. support for Ukraine, U.S. Treasury yields had little change.

Of course, bond traders have prepared for a possible recession in the past few years, but each time they have been frustrated as the economy continues to move forward. Moreover, the three 25 basis point rate cuts that the Fed currently expects this year are not enough to indicate that the Fed will enter a mode of fighting the recession. Last Friday, Federal Reserve Chairman Powell said he was not in a hurry to resume easing, saying "Although uncertainty is at a high level, the economy is still in good shape."

In addition, inflation may continue to put pressure on yields, with this week's Consumer Price Index (CPI) report expected to show prices in February rose 2.9% year-on-year, still above the Fed's 2% target.

However, signs of a cooling economy are also accumulating, including the Atlanta Fed’s GDPNow indicator, which shows that the U.S. gross domestic product (GDP) may shrink in the first quarter.

While the U.S. Department of Labor reported that employment growth was sustained in February, its report released last Friday also provided evidence that the labor market was weakening, including more permanent unemployment, fewer federal employees, and a surge in part-time jobs due to economic reasons.

Edward Harrison, a Bloomberg MLIV strategist, pointed out that "the details of the (employment) report show much worse, and the forward-looking aspects of the report seem to drive the continued rise in Treasury prices. These data support the Fed's early rate cut, which has exacerbated market concerns about the recession, and therefore should continue to drive the recent trend of bond bull markets and stock bear markets in the U.S. financial market."

The direction of the U.S. Treasury market depends largely on Trump's implementation in the coming months. Treasury Secretary Scott Bessent admitted on Friday that there could be turbulence in the economy due to the turmoil, but he expressed confidence in the long-term outlook for the economy.

Trump appeared to respond to some concerns about radical cost-cutting measures last Thursday, instructing cabinet ministers to use a "scalpel" rather than an "axe" when laying off employees. He also delayed the tariff hikes on Mexico and Canada for a month for the second time as the stock market plummeted.

“Before this trade war, the market believed tariffs would trigger inflation, and now people believed tariffs would cause recession,” said Chen from Brandy Global Investment Management. "PlaceWith this, this is a huge change. ”