Bond Market Reacts to Tariff Concerns & Fed Expectations—What’s Next for Yields?

• The bond market is rallying as central banks are expected to ease monetary policy to mitigate the negative impact of the trade war on economic growth. This does make sense, and we expect this to happen. The market is also telling you this with the sharp decline in yields.
• Both JPM and RAYJAY indicated on 04/02 that MUNI bond investors should go long on the curve. This is nothing new to us. However, underperformance has cheapened MUNIs compared to the US Treasury’s, meaning individuals and institutions like insurance companies can buy tax-free debt at yields close to those on taxable bonds. Longer-dated MUNIs carry tax-exempt yields that are 93% of the US government bonds after a surge of new issuance, which we have been discussing over the last few weeks.
• Tariffs have been the key topic for many months. With the 10T dropping at 4% and below for the first time since October, this indicates concern regarding the economy and how Trump’s trade war will impact it.
• I have attached a graph regarding the 10T showing the massive move over the past six months. The steepest increase in American tariffs in a century is causing concern that it will hammer economic growth. As a result of the flight to safety, we are seeing a “global” drop in fixed-income yields.
• Money markets are pricing in a 50% change in the FED’s delivery of four (4) .25% cuts this year, with the first cut coming in June. To put this into perspective, just two (2) months ago, everyone was calling for only two cuts. See the attached graph below.
• Compared to the above, on 3/31, Goldman indicated they now forecast that both the FED and the EU central bank will cut rates three times this year as Trump’s tariffs weigh on economic growth. Goldman anticipates a July, September, and November, cut versus two early this year and one in 2026. We also tend to agree; we don’t think there will be more than three in 2025. The question will be what will happen in 2026.
• Bloomberg reports that they believe the tariffs will produce a “sizeable drag” on economic activity, the equity markets, and the labor markets. The impact on inflation at this time is uncertain, with a FED Model from 2018 suggesting that tariffs could boost the core PCE deflator, the FED’s preferred price gauge, by as much as 1.4%. The bottom line is that this indicates a recession is “more likely” resulting from the tariffs. Should a recession happen, you could see a further flight to quality.
• The revival in small-cap equities expected from Trump’s America First agenda has turned into a rout for shares in companies whose fortunes are most closely tied to the US economy. The Russell 2000 Index plunged 4.5% Thursday, 4/3 and is now down more than 20% from its all-time high, reached late 2021. Although we do not trade equities often, the drastic move in the markets today, 4/3, is intriguing as it directly impacts FI markets.
• As discussed on many occasions, MUNIs typically “lag” T bills by about 2-3 weeks. As of today, 4/3, we have not seen MUNIs react to the extent T bills have reacted regarding the drop in yields. Although yields are down, they are not as down as the T markets. We have been buying longer-dated securities for quite some time. Yields have moved down a bit, but good buys continue to remain in the MUNI sector.

At The DRL Group, we specialize in helping high-net-worth investors maximize tax-free returns by proactively maintaining their custom bond portfolios through all market conditions.

David Loesch
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www.drlgroup.net
605-B Park Grove
Katy, TX 77450
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