SUMMARY
Amid the tariff turmoil, investors may have been shifting somewhat away from US markets. We make the case for certain fixed income assets.
KEY TAKEAWAYS:
Tariff risks – especially sectoral ones – are increasing
The Fed is focusing on inflation rather than rate-cutting to support the economy for now
Volatility has been high, with investors likely shifting somewhat away from the US
With the economic outlook worsening, we favor short- to intermediate-term bonds
Despite some initial positive headlines around tariff negotiations with Japan, tariff risks – particularly sectoral – are increasing. Sectoral tariff reviews for pharma/semis and reciprocal tariff negotiations are only now getting underway.
Many of the countries facing high tariffs don’t have the resources of Japan or the EU to commit to buying more US energy or goods.
Moreover, while ostensibly remaining open to talks, for now the Trump administration appears to be trying to isolate China, publicly stating that reciprocal tariff rates negotiated with other nations might be influenced by those countries’ willingness to curb their own trade flows with China.
Against this backdrop, monetary policy is still not coming to the rescue. Chairman Powell noted that it is “too soon to say” when asked for the Fed’s assessment of the impact of trade policy.
Critically, there is no real precedent for the current proposed tariff regime. Powell will respect both sides of the dual mandate, but for now is primarily focused on inflation, which lessens the chance of any near-term rate cuts.
Cross asset volatility has spiked in 2025. While US Treasury volatility subsided somewhat during the week, US equities closed lower. Gold jumped another 3% in the week to April 18, continuing a remarkable 26% year-to-date gain.
Major foreign currencies such as the Euro and Yen also continued their year-to-date appreciation vs the US dollar, accelerating higher since “Liberation Day” on April 2.
It’s likely that investors are reallocating a portion of their US investments elsewhere due primarily to weaker US equity market return expectations. But these flows may also be in part anticipating that sharply reduced expected global net trade flows into the US will result in smaller capital flows to “recycle” back into the US.
Non-US equities have also outperformed US counterparts, as have German sovereign bonds (or “Bunds”) relative to US Treasuries.
We expect market volatility to remain high, and headline driven. We do not expect a rapid de-escalation of the tariff negotiations, so corporate earnings visibility will remain very low.
Equity positioning and technicals could lead to dramatic market swings, but we are remaining focused on fundamentals – and both the forward earnings and macro growth outlooks are deteriorating. Given that risks remain for the Treasury yield curve to steepen, we continue to favor short to intermediate bonds.
Fixed income recovers
Following reassuring comments from Treasury Secretary Bessent, members of the Fed, and Chairman Powell, the Treasury bond market resumed its more characteristic “safe haven” function as yields fell, resuming its tracking of weaker economic news with about a month lag.
Notably, Chairman Powell indicated that the Fed was likely to emphasize for now the inflation portion of the Fed’s dual mandate, noting that the economy “can’t have a strong labor market without price stability.” In effect, the Fed remains in “wait-and-see” mode and is in no rush to cut rates.
Powell also noted that while current levels of federal debt “is not at an unsustainable level”, it’s “better to address the debt situation sooner rather than later” as the path of federal debt growth is unsustainable.
These comments appeared to be a comment on market concerns over the current US budget negotiations and possibly higher future deficits. S&P, a rating agency, echoed this view on Monday, when it said in a report: “The outcome of the US government's budget process and policy negotiations over the coming months will help determine policies that inform our view of US sovereign creditworthiness.”1
Given the Fed’s reticence to cut rates near-term, longer-term Treasury rates are unlikely in our view to drop much further given uncertainty over future inflation, the possibility of an increasing US budget deficit, and potentially declining future foreign demand for longer maturities.
In addition, as we highlighted in yesterday’s Data Watch, comments this week by President Trump about his dissatisfaction with Chairman Powell and the Fed’s unwillingness to lower rates will be closely monitored by the market.
Should this situation escalate beyond words towards an active effort to remove the Fed Chair prior to his term expiry in May of 2026, bond investors would likely be even less inclined to own longer-dated Treasuries for fear that the any new Fed chair might steer towards overly stimulating growth by cutting rates too deeply.
We maintain that fixed income portfolios have a short to intermediate duration range (3-5 years) and maintain an “up in quality” bias in overall portfolio construction.
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