The combination of the continuous trade war and upcoming recession fears makes for an interesting time in the bond market. These three factors combined have enormous implications for the value of the U.S. dollar. Yet the United States already consumes roughly 16% of the world’s energy. The reason it’s such a critical actor to international markets is because of its massive energy needs. The reality is that free trade has always enjoyed strong bipartisan support, especially among Republicans. It’s their own policies that reveal a breathtaking hypocrisy, making the economic picture far more challenging.
The U.S. economy uses a lot of energy, and that’s now a target on the field. Donald Trump’s trade policies seem to be handing China the global market on a platter. Analysts warn that President Trump’s silo-building tariff regime could be just what the doctor ordered for U.S. hegemony’s demise. Some speculate that Trump’s negotiating tactics may lead to unforeseen deals with countries such as Japan, indicating a more strategic approach than initially perceived.
According to the Wall Street Journal, “Bond traders appear to be betting on a return to normal before long.” This feeling is representative of the bond market’s struggle to weigh competing forces. Worries about a possible recession hang heavy in the air. At the same time, increasing tariffs increase the likelihood of persistent inflation. In fact, the dollar’s strength is positively correlated to the 10-year Treasury bond yield, showing just how interconnected these economic forces can be.
The bond market is still in a recession-fears versus inflation expectations game. Yet as the trade war intensifies, the ripple effects are deepening bond pricing and altering investor sentiment. The basis trade plays a role in this scenario: a strategy where investors buy and sell bonds to leverage price differences is influencing current market activity.
With the U.S. bond market currently experiencing radical changes, it is important to understand just what those changes mean for the U.S. dollar. The strength of the dollar is considered an indicator of investor confidence in the U.S. economy. During periods of uncertainty as with current trade disputes or recession threats, investor sentiment is key. The result can be a deepening of the dollar’s strength or weakness depending on sentiment in the capital markets.
The state bond yield has fallen 60 basis points since the beginning of January. It remains 60 bps above the low of the recent cycle set in September. This paint-by-numbers approach hides some underlying tension within this market. In fact, a recent Reuters analysis points out a surprising, if counterintuitive, trend. Despite a 60 basis point drop since January, the benchmark yield is still 60 basis points higher than its low from September. As most readers know, in just the last five months the S&P 500 has recently cratered by 17%, destroying nearly $9 trillion in market cap. Despite this drop, the 10-year yield has remained relatively flat.
Republicans have traditionally been the party of free trade. Now, they find themselves at an increasing loggerhead with existing policies that undermine these fundamental values. This hypocrisy calls into question the administration’s overall long-term plan to achieve U.S. economic leadership in the new global and rapidly evolving economy.
The cumulate effects of Trump’s trade agenda stretch far beyond the short-term tariff hit. Some analysts contend that such actions would put China in pole position to reorder global economic power relations to its advantage. Japan’s possible bilateral agreement could pave the way for broader talks. It’s possible these discussions could radically alter the future of international trade relations.