Bonds: the final arbiter in the Trump tumult

An iceberg lettuce topped with a Trump-like toupée — that image was featured in a recent Substack article by Paul Krugman, the Nobel-winning economist.

Krugman was making the point that President Donald Trump’s “one big beautiful bill act” — which was passed by a single vote in the US House of Representatives last week — follows the 2022 playbook of then UK prime minister Liz Truss, whose economic policy centred on aggressive tax cuts and deregulation to spur economic growth. Fears that Truss’s plan would result in unsustainable borrowing triggered a vicious bond market sell-off and ended with Truss resigning after just 49 days in office.

As Krugman writes: “The tabloid The Daily Star famously set up a webcam showing a photo of Truss next to a head of iceberg lettuce wearing a wig, and asked which would last longer. The lettuce won.” 

Beyond the similarity of unfunded tax cuts, Trump’s tax and spending plans are far more ambitious than Truss’s ill-fated mini-budget. In addition to expanding and permanently extending his first administration’s 2017 tax cuts, the bill raises the debt ceiling by $4-trillion and allocates billions for defence, border security and mass deportation. These measures are only partially offset by slashing nearly $1-trillion from both Medicaid, the health-care scheme for low-income households, and SNAP (supplemental nutrition assistance programme, or food stamps), as well as the cancellation of many of the green energy incentives, among other measures.

On balance, the nonpartisan congressional budget office (CBO) estimates that in its current form, the bill will add an additional $3.8bn to the federal government’s existing $36.2-trillion debt over the next decade. Treasury bond yields surged after the bill was passed, with 10-year bond yields rising above 4.6% and 30-year bonds soaring above 5% — the highest level since late 2023.

The bill was passed by the house just days after Moody’s stripped the US of its last remaining AAA credit rating — following downgrades by Fitch in 2023 and S&P in 2011 — due in part to concerns over rising US government debt and widening fiscal deficits.

Treasury secretary Scott Bessent was unmoved by the Moody’s downgrade. “Who cares?” he responded during an interview with NBC. Like Truss, Bessent argued that the planned tax cuts and deregulation would boost economic growth, helping the US to “grow out” of its debt. Furthermore, he noted, global confidence in dollar assets remains high, ensuring ongoing demand for US debt.

However, the bond market disagrees. At a recent $16bn auction of 20-year bonds, the first sale of US government debt since losing the final triple-A rating but before the vote on Trump’s bill, demand was unexpectedly weak. Of particular concern was the high yield that investors demanded — suggesting that while there is clearly still demand for US debt, what is in doubt is the price that investors are willing to pay for it.

But unlike the UK in 2022, where markets were roiled by concerns about unfunded tax cuts, financial markets in 2025 are being forced to simultaneously digest the implications of Trump’s erratic trade policy. As an indication of just how unpredictable the trade policy has become, Reuters has tracked shifts in the tariff regime since “liberation day” in early April. By the end of last week, Reuters had counted 20 US trade policy “flip-flops” in less than eight weeks.

Global trade tensions had abated in recent weeks, as Trump announced a 90-day pause of his punitive “liberation day” tariffs in favour of a uniform 10% tariff while trade deals were negotiated. A few weeks later, a 90-day pause on tariffs with China was also announced, reducing the previously announced 145% tariff on Chinese imports to 30%, while China reduced its retaliatory tariffs from 125% to 10%. As trade tensions eased, fears of an impending US recession abated, and financial markets returned to some semblance of normality.

However, at the time of writing, Trump had grown impatient at the lack of progress in trade negotiations, claiming that discussions with the EU were “going nowhere”. This prompted Trump to recommend a “straight 50% tariff” on all imports from the EU effective from June 1, rather than waiting for the 90-day pause to expire.

The EU responded by emphasising that trade negotiations, which typically take up to 18 months to finalise, must be based on “respect, not threats” and that the bloc was ready to “defend its interests”. A day later, a “very nice call” between Trump and EU leaders led to a renewed pause in the threatened tariffs until July.

So, after a few weeks of relative calm, trade tensions are escalating again, along with fears of recession and renewed price pressures, and so compounding the potentially negative impact of Trump’s “big, beautiful bill” on both the economy and financial markets.

The consequences of Trump’s trade policy are already emerging. According to the University of Michigan, consumer sentiment in May declined by almost 30% since January — falling to the second-lowest rating yet recorded. Tariffs were spontaneously mentioned by nearly three-quarters of consumers, while the majority (73%) of Americans surveyed in a recent CNBC/SurveyMonkey poll reported feeling “financially stressed”. Of particular concern to the Federal Reserve, year-ahead inflation expectations among consumers surveyed by the University of Michigan surged to 7.3% in the May survey, while long-run inflation expectations rose to 4.6% — more than double the Fed’s inflation target.

While analysts note that sentiment surveys are soft indicators, the impact of tariffs is being felt in the hard, measurable economic indicators too, with retailers warning that tariffs are driving up prices. However, when Walmart announced it will be raising prices, Trump hit back — telling the company to “eat the tariffs”. Eager to avoid pressure from the White House, other companies have ascribed price increases to “sourcing” or “supply chain” costs. Either way, rising prices are coming, with Yale Budget Lab estimating that tariff-induced hikes will cost the average American more than $2,800.

Apart from households facing higher costs, Trump’s erratic trade policy poses a threat to economic growth. Heightened uncertainty discourages companies and consumers from making investment or major purchase decisions.

Not only will the upward pressure on prices make it more difficult for the Fed to cut interest rates, with no relief expected until later this year, but now higher bond yields — as a result of Trump’s new bill — will raise costs throughout the economy.

The 10-year treasury note — a benchmark rate that sets the tone for mortgage rates and other consumer credit lending rates — has risen above 4.5%.

Higher prices and lending rates and a recession will add further pressure on the more than 10-million people whose access to health care and food benefits will be stripped by the new bill over the next decade. The impact of this decision will be widely felt, as an estimated one in five Americans rely on Medicaid. Furthermore, the CBO estimates that, on balance, the bill will reduce income for the poorest 10% of US households, while boosting income for the top 10%.

Even before the Moody’s downgrade and concerns about the fiscal consequences of Trump’s tax and spending bill, Trump’s roller-coaster trade policies had prompted global investors to re-evaluate their holdings of dollar-denominated assets.

One of the clearest signs of this has been the breakdown of the long-term relationship between US bond yields and the dollar, after Trump introduced his punitive “liberation day tariffs on all trading partners. Typically, rising yields attract capital inflows, resulting in a strengthening dollar. However, despite the recent run-up in bond yields, the dollar has remained weak — losing ground against a basket of its peers and recently testing three-year lows.

The breakdown of this historical relationship suggests the US is losing its safe-haven status. The recent volatility in the US bond markets — caused by Trump’s trade war and more government borrowing — reveals that US debt is failing to play its traditional role as a refuge in times of market stress.

Furthermore, China — long the largest holder of US debt — has quietly been trimming its holdings over the past decade and, as a result, now lags behind both Japan and the UK.

Soaring yields on the bond market forced Trump to backtrack from his “liberation day” tariffs within a week. Yields are rising again as traders in effect try to pressure his administration to provide clarity on trade tariffs, tax proposals and inflation. With the bill yet to pass in the Senate, where it is expected to face more resistance and significant changes, any reversal is likely to take longer this time.

But there is little doubt that the bond vigilantes are getting restless and it would serve the Trump administration well to remember that, ultimately, bond markets always win.