Donald Trump’s announcement on April 2, 2025, that he would raise tariffs caused stock markets around the world to plummet. After the equity markets and the decline of the S&P 500 in the United States, the shockwave spread to sovereign bonds. While a 90-day postponement of tariffs seems to have relieved the markets, the policy of increased tariffs remains a source of tension. This Killer Chart aims to decipher this situation.
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Why is this interesting?
Despite the Trump administration’s missteps, the United States has laid the groundwork for a new era of « trade war, » which raises many questions: what methods and costs of supply in the United States, what repercussions on economic activity, what impact on inflation, on the dollar, etc.?
In a context of high uncertainty, investors are very sensitive to economic policy decisions. Following announcements of the postponement of the DD, investors turned away from the equity markets, which plunged( see dark blue curve on the Killer Chart). Initially, investors turned to traditional safe-haven assetssuch as gold, Swiss franc-denominated assets, and US sovereign bonds, which led to a decline in their yields…
This decline was short-lived, however, as US sovereign debt securities have been in a state of turmoil since Monday, April 7. Between April 7 and 9, there was a rapid recovery in 10-year sovereign yields[2] (see light blue curve on the Killer Chart): investors turned away from sovereign bonds[3]. In the past, similar increases have been observed during: monetary policy tightening by the Federal Reserve (2013, 2015), periods of high uncertainty (inflationary pressures in 2022, presidential campaign in 2024), and even financial crises (2008-2009 crisis, health crisis in early 2020).
What should we make of this?
The explanation for this phenomenon is financial and linked to the repurchase agreement ( repo) market and the strategies of hedge funds (speculative investment funds).
In a traditional repo financing transaction, a borrower is granted funds worth X by a lender in exchange for securities, also worth X, which serve as collateral. If these securities lose value during the transaction, there is a « margin call, » which consists of providing new securities until the value X is reached again. When stock markets contract sharply, the value of stocks tends to fall. As a result, borrowers face increasingly high margin calls. To meet these calls, they must provide new assets, and to acquire them, they tend to first sell liquid assets to raise funds. In a context of falling stock prices and liquidation of equity portfolios, they end up selling the most liquid assets by definition, namely long-term sovereign bonds.
Large, simultaneous sales of long-term bonds can put pressure on sovereign yields. This is the mechanism that has been at work recently. In principle, the postponement of reciprocal customs duties (RCDs) would provide real relief and put an end to this… However, this mechanism is likely to reappear on the day the RTCs are applied and/or as long as there remains doubt about their effective application and the extent of their impact on economic activity.
Recently, hedge funds (HFs) have been particularly affected by liquidations of their equity portfolios and high margin calls. These HFs raise short-term debt in order to invest the borrowed amounts, hoping to maximize their leverage. For some HFs[5], these borrowed amounts were used to take long positions in the bond market via futures contracts, betting on a rise in bond prices[6]. However, as bond prices fell, their leverage quickly diminished, according to Morgan Stanley, exposing them to substantial losses. In such a scenario, the choice is either to unwind positions (which drives bond prices down) or to hedge.
However, the cost of currency hedging has also tended to rise sharply recently, as evidenced by the very marked increase in the 10-year swap rate spread[7] in the United States (yellow curve on the Killer Chart). When this spread, or rate differential, tends to widen, it signals (i) that the perception of interest rate risk is deteriorating, and (ii) that there are significant sell-offs of sovereign bonds.
A deterioration in interest rate risk is quite difficult to interpret. Often associated with a deterioration in public finances, in the case of the United States it appears to be linked more to a change in inflation expectations. Indeed, the unexpected scale of the US tariff increases could ultimately prove to be more inflationary than anticipated. As a result, the Federal Reserve could revise its schedule for rate cuts in 2025, or even consider rate hikes if inflation continues to rise. Such a reversal would put pressure on short-term rates and spread to long-term rates (hence the perception of interest rate risk). Anticipation of interest rate hikes could even lead to an increase in net short positions on sovereign bonds (as has already been the case with the USD for several weeks) and thus have self-fulfilling effects on interest rate risk by pushing bond yields higher.
Beyond the commercial aspects, the undesirable effects of the Trump administration’s tariffs are already being felt on the financial markets. Contagion from the fall in equities to sovereign bonds now seems to have been averted with the pause in tariffs. However, the situation calls for vigilance, as the mechanisms described here could be activated again as July 2025 approaches. In the event of renewed tensions, central banks, despite being in the midst of reducing their balance sheets, may well be called upon once again to prevent a bond market crash.
V.L, article written on the morning of April 10, 2025
[1] Largest amounts sold since 2010 according to Goldman Sachs.
[2] Between April 7 and 9, 2025, yields rose by an average of +11.2 bps per day, well above the long-term average (approximately the average plus two standard deviations).
[3] Yields rise when the price of these bonds falls, which is characteristic of excess supply (sales) relative to demand (purchases).
[4] These collateralized securities allow the lender to avoid losses in the event of borrower default. In the event of default, the repurchased securities become the property of the lender (see this article on clearing houses).
[5] Long-short hedge funds generally take long positions (buying) on securities whose value is expected to rise and short positions (selling) on securities whose value is expected to fall.
[6] Anticipating a fall in bond yields (a rise in prices), these HFs take options to purchase securities, which they exercise when prices rise, counting on reselling them at a higher price at a later date.
[7] The swap rate spread is the difference between the swap rate and the yield on a sovereign bond with the same maturity. The swap rate is a tool for hedging interest rate risk, i.e., a financial contract that determines the cost of exchanging a fixed rate for a variable rate.
[8] However, the United States could do without a reversal of its bond market in 2025, especially since the risk of a shutdown at the end of the year appears to be significant, given the need to raise the public debt ceiling before the very ambitious budget announced by Donald Trump during his campaign can be approved.
