Is History Rhyming? Key Fixed Income Themes During the First Trump Administration

Lawrence Gillum (00:00):

Early in the second Trump administration, tariff threats have revived market volatility. Recent Treasury yield curve movements reflect this uncertainty with markets reacting to both threatened and postponed tariffs against key trading partners. And so far, the price action in the fixed income markets is relatively consistent with how markets performed during the first Trump administration. So in this edition of the LPL Street View, we highlight some of the key fixed income themes that took place under Trump 1.0 in case history is set to at least rhyme. On Sunday, February 9, President Trump announced new tariffs on steel and aluminum imports. These actions were consistent with his campaign promises to protect American industries and reduce the trade deficit through the use of tariffs. These new tariffs are in addition to the 10% across the board tariffs on Chinese imports that went into effect on February 4, reinforcing the administration's tough stance on trade with China.

Lawrence Gillum (00:53):

Additionally, there is the looming threat of 25% tariffs on imports from Mexico and Canada, which have currently been delayed until March 4. Short-term Treasury yields rose as markets pushed back expectations for Fed rate cuts while long-term Treasury yields declined on economic slowdown concerns and potential trade tensions. These yield curve dynamics mirror patterns seen during the first Trump presidency. During the first Trump administration trade tensions between the U.S. and China moved both interest rate and credit markets. As tariffs escalated, two key trends emerged in the rates market. First, investors grew worried about economic growth, pushing them towards safer assets like U.S. Treasury bonds. This pushed long-term bond yields lower even as the Fed kept raising short-term rates. Additionally, international capital flows also shifted dramatically under the first Trump administration. China reduced its U.S. bond holdings by over a hundred billion as tensions peaked, however, global uncertainty actually increased overall foreign demand for U.S. bonds as investors sought safety from trade related market volatility. Manufacturing slow down and supply chain disruptions reinforced these trends.

Lawrence Gillum (02:02):

As global factory activity declined. Investors grew even more cautious, further compressing long-term yields. The result was a flatter and eventually inverted yield curve where long-term rates fell below short-term rates. Fast forward to today, after enduring the longest yield curve inversion in history recently. If history is our guide, we could be stuck with a pretty flat yield curve over the next few quarters, or at least until these threats of tariffs recedes. The other big trend in fixed income markets under Trump 1.0 was volatility, particularly in the corporate credit markets. Now, corporate credit markets have shown remarkable stability despite recent equity and rates volatility. High-yield and investment-grade option adjusted spreads remain near historic tights with high-yield OAS in the third percentile and investment grade in the second percentile of this historical range since 2002. Even triple-C rated bonds, the riskiest segment of the high-yield market, trade in the ninth percentile suggesting investors are showing unusual comfort with credit risk across the quality spectrum.

Lawrence Gillum (03:02):

A repeat of Trump 1.0 trade dynamics could bring heightened volatility to credit markets which enter this period with significantly tighter spreads. Even ignoring the large move higher in spreads during COVID during the 2018– 2019 trade tensions, investment-grade spreads widened 75 basis points from the February 2018 cycle tights, while high-yield spreads widened 225 basis points in just two months. While markets recovered in early 2019, volatility remained elevated throughout the year and unlike 2019 when the Fed supported credit markets with rate cuts amid these straight tensions similar policies support appears unlikely given today's elevated inflationary environment. Credit markets have been remarkably resilient over the past few years due to an economy that has also been remarkably resilient. But it wouldn't surprise us if spread volatility increased from currently very low levels. And with spreads near all-time tights, we don't like the risk reward in corporate credit markets currently.

Lawrence Gillum (03:59):

As for the rates market, while tariffs could initially drive a lower trading range through safe haven flows, any significant escalation could eventually push yields higher if tariffs prove inflationary, supply chains reshore, and or China reduces Treasury holdings more aggressively. The key will be monitoring the balance between growth fears, which means yields lower, and inflation risks, yields higher, in any new tariff regime. However Trump 2.0 plays out fixed income investors may be in store for another bout of volatility. That's it for now, but for more information on global capital markets, make sure you're following us on our social media accounts. Take care, everyone.