John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.
Traders work on the floor of the New York Stock Exchange, on April 17.Richard Drew/The Associated Press
Following the wild gyrations of the previous two weeks, an uneasy calm settled over markets this week thanks to President Donald Trump’s partial retreat from his tariff blitz. He had little choice. His “Liberation Day” had sowed panic in markets, and all major asset classes – stocks, bonds and the dollar – fell sharply. The administration had tried putting a brave face on it, saying it wouldn’t cave to a few “yippy” investors, but it couldn’t hide that something unprecedented and alarming had happened.
Ordinarily, when bond yields surge, so does the dollar, as foreign investors lock in the higher rates on U.S. Treasury paper. However the dollar recently began falling alongside bond prices, a pairing normally seen in emerging-market panics. But amid Mr. Trump’s radical shift in policy, the United States is apparently no longer regarded as a safe haven. If Mr. Trump didn’t pause, the market might crash.
Score one for markets, then. However, the truce may prove temporary. Although bond prices rallied this week, which helped bring interest rates back down from last week’s peaks, it didn’t reflect a renewed vote of confidence in the American government. Rather, investors appear to be increasingly planning for a recession, and so are buying bonds at rates they think will exceed just about any other investment they could now make. Stock indexes kept falling and the dollar continues south, its decline since the start of the year now closing in on 10 per cent.
Does Donald Trump really think he can win a trade war against China?
What makes things particularly troubling for the administration is that it appears to be not just foreign investors who are pulling up stakes in America. Rich Americans seem to be heading for the exits also, and moving their money to the perceived new safe havens in places like Switzerland. What doesn’t seem to have begun yet is large-scale selling by foreign central banks. However, that’s cold comfort since it means the worst could be yet to come. If, say, the tariff war heats up and the Chinese decide to weaponize their foreign reserves by liquidating their large store of U.S. government bonds, they could drive American interest rates skyward.
That would knock the legs out from under the administration. Higher interest rates are already making it hard for Mr. Trump to pursue his policy agenda. His desire to both extend the 2017 tax cuts while reducing other taxes relies on the government freeing up funds elsewhere. To date, though, Elon Musk’s Department of Government Efficiency (DOGE) has failed to make a significant dent in spending and the budget deficit continues growing – thanks to the government’s rising interest bill. Meanwhile, as investors grow jittery about the economy’s prospects, they are demanding sharply higher rates on lending to corporations, which will slow investment and economic growth, further limiting tax revenues.
Unless Mr. Trump can find a way to bring down interest rates, his presidency will amount to the sound and fury at which he specializes but which will – as in Shakespeare’s Scottish tragedy – signify nothing. And while there are homegrown ways he could try to lower interest costs to keep things on track, all of them bring their own problems.
He could, for example, stick with his tariffs, allow markets to fall further and induce a recession. That would prompt the Federal Reserve to cut interest rates. There are days when the administration says this is the plan, but this appears to be rationalization rather than something they actually intended. Besides, unless the White House can ensure any resulting recession would be brief, it would be politically suicidal.
Instead, Mr. Trump could go the other way, put up his hands, say ‘I tried’ and abandon his protectionist program altogether. In that event, bonds and stocks would both rally, and happy days would return to Wall Street. But since that would amount to an unconditional surrender, it would probably be equally self-harming politically.
Finally, Mr. Trump could prod the Federal Reserve to underwrite his program both by cutting short-term interest rates and, if bond investors continue to lose faith, stepping into their place and buying the government’s bonds itself – in effect, by resuming its controversial strategy of quantitative easing. The Fed’s unlikely to agree to this, though. Aside from the fact it’s not the central bank’s job to underwrite bad government policy, were it to buy bonds at artificially low prices, it would risk losing the confidence of investors that it’s acting independently. Investors could then dump their bonds, forcing the Fed to buy even more. All that money would then enter the economy, stoking inflation. Instead of making America great again, it would make it Zimbabwe.
So there’s really no happy outcome for Mr. Trump. Sooner or later, having promised more than he can deliver, he’ll have to abandon one of the planks of his platform. Because even a U.S. president can’t beat the bond market.
