Amid the whipsaw changes in President Trump’s tariff announcements the last two weeks, something unusual has been happening in the critically important — and immense — market for U.S. Treasuries. When Trump unveiled his expansive tariff plans on April 2, investors quickly concluded that the massive new taxes might trigger a recession. The stock market swooned and the yields on Treasury securities plunged — as you might expect, because these are conventional responses to a prospective downturn.
But then, earlier this week, even as the stock market remained weak, something changed: Yields on longer term (10- and 30-year) Treasuries turned up and even eclipsed pretariff announcement levels. That seemed scary. Was some big holder of Treasuries — China quickly became the obvious suspect — dumping them? Many have worried for years that the Chinese could make their holdings of more than $700 billion of our debt a weapon of economic warfare.
While anything is possible in opaque global markets, that seems a less likely solution to me. For one thing, some experts believe China tends to own Treasuries of much shorter duration . More likely, what was happening to Treasuries is an example of the strange behavior that can occur in times of financial and economic stress.
In this case, a probable — but by no means certain — explanation is that following the tariff announcement earlier this month, the market quickly took its anticipated number of Federal Reserve interest rate cuts this year to four from three. That in turn, changed rates up and down the “yield curve” — the range of Treasury maturities from very short term to 30 years.
Hedge funds and other dealers often engage in very sophisticated forms of arbitrage, betting on small discrepancies between the price of one Treasury and another. Because the discrepancies are so small, large amounts of leverage are often employed. When a re-pricing or fear of one occurs, investors can seek to unwind these trades quickly, causing unusual and cascading price movements.
If things get bad enough, the Federal Reserve can step in to provide liquidity, as it did in the early days of Covid in March 2020. Or the Treasury market can normalize on its own. And of course, there’s always the chance that this time could be different.
