Whither Treasury Yields?

Since I am allegedly writing about the intersection of the bond market and economics, I need to periodically check in with what is happening in the bond market itself. (Since I am not plugging financial forecasts, I do not have the pressing need to point out how brilliant my calls are — or why the markets are wrong — which is a constant source for articles for most other commentators.)

When we look at the figure above, it appears that nothing interesting is happening in the U.S. Treasury market from a big picture point of view. The 2-/10-year curve is mildly steepening (but well below cyclical peaks), and the level of the 10-year yield itself is trading in a range.

If these were the only financial data figure one looked at, one might think that the Trump first term is passing without incident. However, this placid appearance is perhaps somewhat misleading. The bond market is caught between two contradictory forces: some investors want to get out of U.S. dollar-denominated securities, while the U.S. economy is careening towards recession. The path of least resistance is for yields to track largely sideways. (This makes sense, since the foreign investors may be somewhat price sensitive, so they sell into any attempt to rally, but do not dump into a sell off.)

A recession determination call is going to be controversial, and I expect that President Trump will eventually pen an Executive Order declaring that the economy is not in recession and/or the recession started in Biden’s term. We would not have a recession call from the NBER until well after it is started. (As a reminder, the standard definition of a recession is not two quarters of declining real GDP, it is a determination made by the NBER based on a range of monthly activity data. ) I have not seen enough deterioration in activity recession to indicate that the U.S. is in recession now, but the collapse of supply chains is already baked into the cake. Firms are now just running on existing inventories and what was already in transit.

There is considerable hopium about Trump doing some deals that will prevent a catastrophe. Although I concede that is possible (since it is the only sane course of action), I am skeptical that things will work out.

1. The 100+% tariffs on China are going to crush small and medium firms that rely on Chinese inputs to their own production. Many will have a hard time financing orders already placed when the working assumption was that tariffs might only increase by 20%.

2. The disruption to oceanic shipments will blow a massive hole in the trucking industry, disrupting logistics. Containers flow in a shipping cycle.

3. Cutting a deal would require the American negotiators to know what they want. The constant refrain from foreigners is that the Americans have no actual demands that can be discussed, since everything is dependent upon the whims of one man who is mainly playing golf and posting threats to his enemies on social media. And to the extent that demands exist, they are non-starters. (For example, Trump again posted a complaint about the apparently fictional “bowling ball” test applied by Japan on cars.)

4. The destruction of American international tourism is not about tariffs (the standard framing in American media), it is due to anger that result from invasion threats as well as the fear created by reports of overreach by border control on tourists.

5. Delaying the implementation of tariffs on many countries again is one likely attempt at a reprieve, but is unlikely to apply to three large trading partners: Canada, China, and Mexico.

6. The only off ramp that appears to be palatable to Trump is that countries announce non-existent/trivial concessions (like Canada creating a “fentanyl tsar” and announcing policy changes that were already announced before the American election). The problem with that off ramp is that the idiotic “peasants” remark by J.D. Vance appears to have the Chinese leadership looking for revenge.

7. The main stumbling block to deals is that the White House is largely oblivious to political realities in foreign countries, while foreigners have no choice but to be conversant with the details of American partisan politics. Everyone can smell blood in the water, and the only countries that might want to cut a deal are either very poor, ideologically aligned, or have leaders whose skulls are filled with bangers and mash (e.g., Starmer).

Concluding Remarks

It takes time for goods to ship across the Pacific. (For example, now is the time retailers make back-to-school goods orders.) The economy is very much in a Wile E. Coyote moment — over the cliff, but has not yet looked down. By the time the hard data shows problems, it will be too late.

Appendix: Canadian Election

One interesting feature of this election is that advance polls were open Friday to Monday (coinciding with the full Easter long weekend) from 9 am to 9 pm. Everyone in my immediate circle has already voted. (Friday set a record for advance voting with 2 million votes cast.) As such, the importance of any last minute polling swings are diminished. The advanced polls are only counted once the polls are closed on election day (although they have an option to start counting them an hour early if there is sufficient volume) so that there are no leaks of results.

Although my riding is deep red (the Liberal candidate may already have enough votes to win, even without counting Liberal votes from election day itself), the projections of it being a complete blowout of the Conservatives are fading. That said, it still appears that the best plausible outcome for the Tories is to hold the Liberals to a minority government. One major question about Conservative support is that they are most popular among young men — who have the lowest propensity to vote.

A Liberal victory would ensure that Canada will take a hard line negotiating stance and will use fiscal policy to offset the drag from trade.

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(c) Brian Romanchuk 2024