(Bloomberg) -- Traders are piling into bets that the Federal Reserve will resume cutting interest rates as soon as May as President Donald Trump’s tariff hikes threaten to upend an already weakening US economy.
Those concerns, which have been building over the last two weeks, are ushering in a major recalibration in financial markets. Stocks fell, short-term Treasury yields slid and traders began betting the US central bank will resume easing policy as Trump’s policies stall a surprisingly resilient economy that’s powered much of the world’s expansion.
The risk the engine will stall was heightened as Trump’s tariffs on China, Canada and Mexico drew swift retaliation, fanning concerns about an escalating trade war. That comes just as his aggressive moves to fire government workers and slash federal spending exert another drag on US growth and consumer confidence erodes.
“Global markets are more concerned about economic growth — and not inflation — as it relates to the ratcheting up of tariff policies,” said John Brady, manging director at RJ O’Brien. Beyond tariffs, “it is the fundamental reversal of US government spending that is driving growth and confidence concerns,” and the administration “has made it clear that the fiscal profligacy of the last four years has ended.”
While short-dated bonds pared their advance by midday in New York trading — and longer ones were up on the day — the market’s recent rallies have marked a sharp break with what had initially been expected from the Republican’s return to the White House. Late last year, traders plowed into bets that his policies would keep interest rates elevated by pouring tax-cut and deregulatory stimulus onto an already solidly expanding economy.
Both Trump and his Treasury Secretary, Scott Bessent, have said they want interest rates to come down, which would lower mortgage- and credit-card bills that have been a drag on US households. But the plan Bessent laid out for doing so involved tackling inflation by reducing energy costs and slashing the deficit enough to ease Wall Street’s concerns about the ever-rising supply of new government bonds.
Instead, yields have slid steadily since mid-February on anticipation that the Fed will shift back to dialing down interest rates again as concerns about a slowdown in growth overshadow still-elevated inflation. That’s caused stock prices to tumble from recent peaks, leaving major indexes with a loss so far this year.
Futures traders are pricing in nearly even odds that the Fed may resume cutting its benchmark rate again in May and will drop it by three-quarters of a percentage point by the year’s end.
The Treasury gains Tuesday were led by shorter-dated securities most affected by monetary policy shifts, with two-year rates sliding as much as 11 basis points before paring the drop. Long-term yields edged up, with the 30-year rising 4 basis points.
That steepening of the yield curve was mirrored in Europe, where traders similarly amped up wagers on easing from the European Central Bank. Meanwhile, Trump’s decision to cut off military aid to Ukraine is poised to fuel a jump in EU defense spending, rekindling concerns about government deficits and pushing longer-term yields higher.
The US’s imposition of tariffs on Tuesday ended the question over whether Trump was using them as a negotiating tactic and would ultimately opt not to follow through. That speculation was spurred by his decision to initially delay them on Canada and Mexico to give more time to reach a potential agreement.
The new 25% duties on most Canadian and Mexican imports — and the decision to raise those on China — impact roughly $1.5 trillion in annual imports. They prompted retaliatory levies from both Canada and China, while Mexican President Claudia Sheinbaum said she will announce tariffs and other measures in response on Sunday.
“The market has to reprice these tariff risks now that they have become reality,” said Kathleen Brooks, research director at XTB. “Markets may remain jittery for the next few days as we wait for the US payrolls report on Friday.”
The increased trade tension comes as other data casts a shadow over the outlook for the US economy. Data this week on factory activity suggests it is edging closer to stagnation, raising the stakes for the widely-watched labor market report.
Beyond tariffs, markets on Tuesday were also contending with the US pausing military aid to Ukraine and the EU’s defense spending. That spurred a wave of risk aversion, with the Swiss franc and Japanese yen leading gains by Group-of-10 currencies against the dollar.
“It’s going to be a bumpy ride,” said Chris Turner, head of FX strategy at ING, adding that plans for aggressive defense spending in Europe and concerns around the US economic outlook are weighing on the greenback for now. However, “we still think the dollar will broadly strengthen in the first half of the year.”
--With assistance from Greg Ritchie and Michael Mackenzie.
(Updates market moves throughout.)
