Federal Reserve Chairman Jerome Powell said just last Friday that there's no rush for policymakers to cushion the blow from escalating Trump tariffs. Yet he may already be rethinking that view as Treasury markets come unglued, with investors dumping U.S. sovereign debt amid President Donald Trump's unprecedented assault on global trade flows.
Long-term Treasury yields are spiking higher, even as Trump tariffs are dealing a massive blow to the global economy and corporate profits, while triggering an S&P 500 rout that's on the cusp of a bear market. At times like this, Treasury yields typically slide as investors seek a safe place to park their money as the economy teeters.
Yet investors are tumbling Treasury bonds. The 10-year Treasury yield surged more than half-percentage-point this week as of early Wednesday, rising back to its highest level since Feb. 20, when the S&P 500 was within 1% of its record high. A jump in Treasury yields will exacerbate the economic hit from Trump tariffs, boosting mortgage and auto-loan rates.
The 10-year yield was at to 4.43% around 11 a.m. ET, after eclipsing 4.5% overnight. It's not clear where the Fed's line in the sand is. Today's 1 p.m. public auction of $39 billion in 10-year Treasury notes will provide a key test of market demand.
The S&P 500 lost a fraction in late morning trade, continuing to swing up and down, not far bear market territory.
Fed Loses Sway On Financial Conditions
Financial conditions are tightening to an extent that the Fed likely finds alarming. Monetary policy works indirectly, by affecting financial conditions. But if the Fed thinks it has loss control of the Treasury market, exacerbating risks to the economic expansion and its full-employment mandate, policymakers may have to act quickly.
Given the inflationary effects of Trump tariffs, "the Fed is unlikely to intervene to adjust their monetary policy stance," absent a clear deterioration in the macro outlook, Matthew Raskin, fixed-income strategist at Deutsche Bank wrote Wednesday. "What could prompt Fed intervention, however, is a breakdown in market functioning."
Raskin said financial "conditions are not yet in place for Fed intervention," but things are moving quickly, he added. Intervention, if it comes, would likely be done to support market functioning through asset purchases or "measures to ensure ample liquidity."
If the Fed does intervene, that should provide support to the S&P 500, but it won't likely spur a sustainable rally as long as Trump tariffs are a massive weight on the economy and confidence needed to spur investment and consumption.
Why Trump Tariffs Are Spiking 10-Year Treasury Yield
A number of factors have likely contributed to the ungluing of Treasury markets. The other side of the coin of the massive trade deficit Trump is attacking is the foreign investment that has helped propel the S&P 500 and made it a breeze to finance $2 trillion federal budget deficits. Net foreign investment in U.S. financial assets reached $26.2 trillion at end of 2024.
In the face of escalating Trump tariffs and their economic fallout, it's possible that foreign governments and individuals are repatriating capital, contributing to disorderly Treasury markets. Analysts also have pointed to the unwinding of massive hedge fund positions in Treasuries as a likely culprit and a potential target for Fed intervention.
The bond sell-off "might have reflected a broader scramble for cash as margin calls amid the extreme market volatility," wrote John Canavan, lead U.S. analyst at Oxford Economics. "The volatility is also likely forcing an unwinding of massive basis trading activity, whereby hedge funds have been holding near record net short Treasury futures positions offsetting their cash Treasury positions."
Apollo chief economist Torsten Slok wrote on Tuesday that highly leveraged basis trades add up to $800 billion, calling it "a potential source of instability."
Last month, Brookings published a paper co-authored by University of Chicago professor Anil Kashyap recommending "that the Federal Reserve, in periods of extreme stress, be prepared to take over the hedge funds' positions."
