The Bond Market is Worried About the Impact of Tariffs
On April 11th, 2025, the US 10-year yield had its largest increase of 72 basis points (0.72%) since November 2001, and the 30-Year yield saw the biggest surge since 1982. Bonds and yields are inversely correlated; when yields increase, the underlying bonds decrease in price. The US debt level is massive, with over $36 trillion of debt, and of that, nearly $29 trillion is held by the public. Due to the sheer size, any sudden change in the yield of the debt can have global effects well beyond the debt market.
Since “Liberation Day” when Trump imposed sweeping tariffs across the world on April 2nd, bond yields have risen, and equity markets have declined and have had a sharp increase in volatility.
But on April 11th, the bond market broke with yields surging. With Trump stating the bond market is “tricky” and that it is getting “yippy”, causing a reversal on the high tariffs on all countries besides China to a 10% baseline. Still an increase before April 2nd, but less extreme.
At the same time, the US and China have now retaliated with tariffs of 145% on China and 125% on the US for each country’s respective imports, hamstringing any trade between the two countries. The US/China tariff & trade policies have had heightened volatility, and depending on when you are reading this, levels may be significantly different.
The bond market’s reaction to the tariffs was likely a driving force behind the policy reversal for most countries.
Tariffs and the uncertainty are the initial reasons why the drop has occurred, but speculation on who is selling the bonds varies from central banks in China to Japan to Canada, amongst others or even hedge funds unwinding basis trades. Speculation is rife, but likely due to the widespread and significant usage of US dollars and treasuries in financial markets, there was likely a multitude of players at work. Once foreign exchange reserve levels are reported by countries, any shifts may become more apparent. Further, non-state holdings are more difficult to track and add further opacity. As well, holders of US debt may not look to acquire additional securities, which will also impact treasuries, even if they are not actively selling. But what is clear is that the US bond market is unstable compared to its historic stability.
Investors do not want to invest in unstable environments, even if the underlying economic strength remains strong; uncertainty will reduce investment. Further, a reduced level of investment can induce economic weakness. Investors and capital markets do not want to put capital into assets and projects that may not be viable from one day to the next. A degree of policy certainty is needed to make any meaningful commitment to long-term investment. Whether the investment is in US dollars or a new manufacturing facility.
The Dollar is dropping.
Foreign entities holders of US government debt are inherently long the US dollar at the same time. When the Debt market shakes, so does the Dollar’s value and vice versa. The US Dollar index (“DXY”) is the commonly used way to value the US dollar against a basket of other major currencies. The DXY has fallen dramatically in tandem with the volatility in the bond market.
The dollar was riding high at the start of 2025, but has shifted sharply downward since at an accelerated rate. The dollar has fallen ~9% since the start of the year, a significant move for the reserve currency.
Unlike bond yields, we don’t need to go as far as to see the dollar as weak. The DXY is at a similar level to the low in 2023, and before that, it was notably weaker in 2021. Unlike yields, the Dollar has not had the same shift, but a structural currency shift would take place over years or decades, not days and weeks. Nonetheless, the US Dollar is materially weaker due to the foggy and hostile policy and diplomacy.
How did the US Dollar become Dominant?
The US dollar was established as the world’s de facto reserve currency in 1944 with the Bretton Woods agreement fixing gold at $35/oz. Then in 1971, Nixon suspended the fixed gold exchange rate, causing a switch to the current floating rate fiat system. For the last 80 years, it has remained dominant with very little questioning. However, in 2025, the reserve currency status is becoming increasingly questioned as Trump’s tariffs look to structurally change international trade. While Trump and his administration’s plan has been rather unclear and inconsistent about its goals, what is clear is the desire to reduce the consistently massive American trade deficit and bring back manufacturing to the US.
(source: :https://www.bea.gov/news/2025/us-international-trade-goods-and-services-december-and-annual-2024)
The country has had a consistent streak of annual trade deficits since 1975. While the country does have bilateral trade surpluses with some countries as a whole, the United States are the consumer of the world.
However, the reduction of the US trade deficit means that the world has less of a reason to hold US dollars and US treasuries. Right now, the US uses dollars to purchase foreign goods then the foreigners use much of their US dollars to purchase US financial assets, specifically treasuries, funding the US fiscal deficit. The US continuously consumes more than it produces, meaning it is reliant on debt to fund this consumption. Due to a reserve currency status, the dollar has remained strong. If foreign players do not reinvest their US dollars in US financial markets and either buy US goods or sell the US dollar for another currency, the US dollar would naturally weaken. It has been appealing for foreign nations to hold US dollars & assets as it has been stable with minimal restrictions for use. This dynamic has caused a further proliferation of US assets worldwide. At least $8.5 trillion of US debt is held by foreign entities in US-based broker-dealers.
Due to the US dollar’s use throughout the global financial system, no one country holds a lion’s share of US treasuries.
Share of Foreign-held securities in US-based broker-dealers by Country
During times of crisis, the US dollar has generally strengthened due to the perceived safe haven aspect, as seen in the 2008 crisis and more recently the COVID crash. But with the US-implemented tariffs, this time has been different. The cause of the global economic structure volatility is coming from the US and is completely by choice. So the dollar is weakening both because of the fundamental impact of tariffs, coupled with the instability of the administration’s policy. The Dollar’s lack of strength in a time of crisis is perhaps the most profound shift, indicating real structural change.
Foreign treasury investors have been hit with a double whammy, as both the US dollar and Treasuries have dropped in tandem. So, investor losses in their domestic currency have been multiplied.
While not outright said by the Trump administration, likely due to the political optics, the administration wants a weak dollar. Treasury Secretary Scott Bessant has said they “don’t want other countries to weaken their currencies, to manipulate their trade.” At the same time, the administration wants the US Dollar to remain the world’s reserve currency. A weak dollar makes the country’s exports more appealing in the world market while making imports less appealing for US consumers.
But the US gains additional influence through its reserve currency status. The US can dictate trade between countries, sanctioning entities opposed to US interests. In 2022, the US froze Russian Dollar reserves and locked it out of the global financial system in light of Russia’s invasion of Ukraine. The Dollar system can and has been weaponized, which can be a cause for concern for any nation not aligned with US interests. Dollar weaponization concerns were minimal, but are now heightened with the aggressive tariff policy.
Some analysts speculate that a “Mar-a-lago accords”, a term coined by Zoltan Poszar, may occur, similar to the 1985 Plaza accords to devalue the US dollar. This may be harder to execute as the US would need China to agree, alongside the easing of tensions with allies angered by the recent round of tariffs. The chair of the Council of Economic Advisers, Steven Miran wrote a paper, “A User’s Guide to Restructuring the Global Trading System”, stating the US could look to force a swap of short-term US treasuries to century bonds. This would be akin to a strategic default in the US’s favour at the expense of holders. A change in this manner could invoke an increase magnitude of volatility across global financial markets. It should be noted that Trump has not directly discussed this, but the fact that a US default is even in the conversation exhibits the heightened concerns.
The unstable policy has led to the question among asset managers if the US needs to have a discount rate premium embedded in its assets, similar to emerging and developing markets. Any risk premium would be a stark contrast to the desired goal of a reserve currency. An increased risk premium would depress any US asset value from treasuries to stocks.
If Tariffs are rolled back, confidence in the US dollar may remain low until a long enough stretch of stability occurs. Strong financial markets need a clear view of stability.
Why does a volatile US Dollar & Bond Market matter?
You may not invest directly in US treasuries, but the impact of the shifts will likely directly and/or indirectly impact your investments.
Impact on the US and its Deficits
Near-term financial markets will remain volatile, which, if great enough, will be impactful outside of the financial world. Tariffs will cause US economic growth to slow, coupled with increased yields, the US deficit may have the opposite desired effect of Trump’s administration of increasing. Tariffs do bring in tax dollars, but the impact of a slowing economy and likely increased interest rates will more than offset any tax receipts, further increasing the fiscal deficit. The net interest expense for the US federal government is its second-largest line item, more than defence and Medicare, only less than Social Security spending. A sharp rise in interest rates will make any fiscal deficit even more difficult to close, further causing increased debt. While unlikely, higher interest rates will cause an increased debt load, which can cause a debt death spiral, which would likely result in hyperinflation. The more likely scenario would be further shifts in US spending and policy, where it lands is purely speculative. Generally, high interest rates are hard for the US government to manage with the massive debt load.
Settlement Currency Effect
The US dollar is the settlement currency for many commodities and assets. If the US dollar remains volatile, the relative value of US dollar-denominated commodities will also be volatile. But in terms of other currencies, the price volatility of the commodities may not be seen or to a lesser extent. Gold has increased in value relative to other currencies, but due to the weakening of the US dollar at the same time, and being commonly quoted in US dollars, the value appears to have increased more so. It is notable for Gold as it is seen as a historic reserve asset it can benefit from a movement away from the US dollar.
However, it’s not just gold; a devaluing US dollar will impact any asset priced in US dollars. Take copper, an asset that has declined during this recent period; the weakening US dollar has made copper’s decline seem less severe in US dollar terms.
Foreign Exchange Impact for Companies
Due to the importance of the US dollar and the US in trade, many companies have US Dollar revenues and costs. Companies with US dollar revenue and non-US dollar costs have benefited from a strong US dollar. If the US dollar structurally depreciates, companies with this exchange structure will be impacted negatively, and vice versa. This can create an opportunity for investment as valuations may not fully reflect shifts in currencies, even if short-lived.
What Now?
The certainty of any macroeconomic prediction is very low. Whether this is a blip that will be a footnote in a future textbook or redefine global financial markets is unclear. Much of what will happen depends on one man, Donald Trump.
While this post has been quite negative, that does not mean you should just sit out the market. Volatility will create investment opportunities. As the financial markets shift, volatility can and will result in misspriced assets and stocks. For investors who are willing to withstand volatile markets, the resulting reward can be lucrative years down the road. At KeyStone, we look under every stone within Canada and the US for unknown and overlooked stocks. We expect to be able to find great value in times of crisis and structural change.
