U.S. government debt yields added to steep May declines on Friday after President Donald Trump’s new tariff threats on all Mexican imports took investors by surprise and aggravated an already-stressed U.S. trade outlook.
At 4:07 p.m. ET, the yield on the benchmark 10-year Treasury note was lower at around 2.135%, off a fresh 20-month low around 2.125% hit earlier in the session. A portion of the yield curve remained inverted as the yield on the 3-month Treasury bill held at 2.351%. The 2-year rate dropped 13 basis points to 1.926%, it’s lowest level since January 2018.
The 10-year German bund yield hit a low of -0.213%, its lowest level ever back through records that began in 1988.
The flight to safety on Friday came after Trump said the night before that he will impose a 5% tariff on all Mexican imports starting June 10 if Mexico didn’t take unspecified steps to shore up the border, potentially undermining the recently negotiated deal between the U.S., Canada and Mexico.
“While the essential ingredient to the overnight rally is unquestionably the President’s threat of tariffs on Mexican goods unless illegal immigration is stopped, the broader backdrop is equally as supportive for Treasuries,” Ian Lyngen, head of U.S. rate strategy at BMO Capital Markets, wrote in an email.
“The ongoing policy quandary of ‘what will it take to get the Fed to cut?’ has been complicated by the gradual nature of the stock selloff which has kept equity volatility, and therefore the tightening in financial conditions, relatively tame,” he added. “Nonetheless, financial conditions are at the tightest level seen since January and the pace of the move is comparable to December.”
Trump’s Mexico tariffs also represent the White House’s latest attempt to pressure an economic partner through the use of trade levies, a tactic Trump has relied on throughout his negotiations with China. The administration imposed 25% tariffs on $200 billion worth of Chinese imports earlier this month following a breakdown in talks between Beijing and Washington.
The stall in U.S.-China talks triggered — in addition to the more expensive imports — a paradigm shift in Wall Street’s upbeat markets and economic outlook. Traders who had been betting on a lukewarm to positive resolution with China punished risk assets like equities in favor of safer assets like U.S. Treasurys, sending the prices of debt higher and yields lower.
The S&P 500 — down 6.5% this month — tracked a 34-basis-point drop in the 10-year Treasury rate, which in turn inverted a portion of the yield curve. Such inversions are often seen as a recession indicator as those who buy debt from the U.S. government for years are compensated with poorer rates than those who loan money for a matter of months.
The difference between the rate on the 3-month Treasury bill and the 10-year Treasury note was last seen at -21.8 basis points. The spread between the 10-year yield and the 2-year yield remained at a positive, albeit flattish 21 basis points.
But while market focus on Friday centered on Trump’s latest tariffs, other bond strategists noted what the larger change in outlook could mean for the Federal Reserve. A growing number of investors now expect the Fed to cut its overnight lending rate later in 2019 as the boost from Trump’s tax cuts gives way to mounting trade disputes and weaker economic data overall.
“At the beginning of the year, I said that the 10 year was heading to a 2.25% yield, in my opinion, and maybe even through that. I now believe we are heading to a 2.00% yield for the 10 year Treasury,” Mark Grant, chief global strategist of fixed income at B. Riley FBR said in an email.
Chair Jerome Powell said in March 2018 that “there’s no thought that changes in trade policy should have any effect on the current outlook,” has in recent months tweaked his rhetoric, especially around Europe and China. Twelve months following those first comments on the Trump administration’s trade tactics, Powell said that the weaker overseas outlook is dampening domestic growth estimates.
“Much discussion is made of this suggesting a Recession is forthcoming but that is not my take,” Grant added. “The Fed, for its own portfolio, has not bought Treasury Bills, a policy that I think will be reversed, and then the Yield Curve will begin to normalize as the Fed’s assets include the shorter end of the Curve.”