Should You Avoid Long-Term U.S. Treasury Bonds Due to President Trump's Tariffs?

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President Donald Trump's tariff-raising campaign has highlighted the extreme volatility in the bond market. When he initially announced the extremely high tariff rates on imports from most countries, many economists cut their estimates for U.S. gross domestic product growth. Similarly, traders ratcheted up their bets that the Federal Reserve would cut interest rates based on the premise that tariffs would slow the U.S. economy and threaten to push it into a recession.

Usually, when conditions similar to these occur, Treasury bond prices rise -- which means their yields fall -- because movements in the bond market tend to be a reflection of investors' expectations about economic growth and the directions of interest rates. Investors also tend to rush toward safe assets when they are worried about economic slowdowns. Generally speaking, when stock prices move downwards due to market fears about slowing growth, bond prices tend to rise.

But amid these wild market conditions, longer-term yields have not followed their usual predictable script. Initially, Treasury yields fell hard on the tariff talk, but in recent days, they've surged, with the yield on the 10-year U.S. Treasury nearly reaching 4.5%. Even after Trump on Wednesday put a 90-day pause on the larger share of his new tariffs for most countries except China, the 10-year Treasury yield, as of Thursday, was still at 4.35%.

In light of all this, should investors avoid longer-term U.S. Treasury notes and bonds right now?

Something odd is afoot

While the Federal Reserve's benchmark federal funds rate influences Treasury yields, they are more or less driven by the market's expectations. Treasury yields have been in focus for several years now, with bond investors increasingly focused on the U.S. debt situation. The federal government ran a deficit of more than $1.8 trillion in its fiscal 2024, and carries more than $36 trillion in total debt.

There are a few reasons Treasury yields surged during the tariff chaos, and none of them are particularly bullish for the economy or stock market. A positive reason for higher yields would be a renewed belief in economic growth, but traders instead have been increasing their bets that the Fed will cut interest rates. At this point, the median view among options traders is still that there will be three quarter-point rate cuts this year, although it's important to recognize that these predictions change often.

However, Fed Chair Jerome Powell has been clear that he's not going to cut rates into an economy that's on solid footing, especially with annual inflation still over the Fed's 2% preferred target. This means that if rate cuts happen, it would likely be in the context of supporting a weakening U.S. economy or one on the precipice of recession.

Another reason longer-term yields like those on the 10-year and 30-tear U.S. Treasuries could be rising is due to inflation expectations. Economists generally view tariffs as inflationary. Powell previously said that his base case was that tariff-induced inflation would be "transitory," but after Trump imposed much steeper tariffs than expected, he pivoted, warning that their inflationary impact could be "more persistent." Higher Treasury yields as a market response to high inflation would not be a good sign.

10-Year Treasury Rate data by YCharts.

Lastly, the rise in longer-term yields could have something to do with the country's debt situation. According to the U.S. Treasury Department's monthly statement of public debt, the government has about $6.15 trillion of Treasury debt maturing between now and March 19, 2026.

About a quarter of all U.S. debt is owned by foreign investors, according to Federal Reserve data. Growing tensions with large buyers of U.S. debt -- in particular, China -- could impact their interest in buying U.S. Treasuries. And if those large holders sell bonds in quantity, they'll increase the supply of Treasuries on the market, driving prices lower and yields higher.

Billionaire investor Jeffrey Gundlach, the founder and co-CEO of DoubleLine Capital, recently said on CNBC that if the U.S. continues to ratchet up its conflicts with other countries, they will be less likely to continue to purchase U.S. debt. Furthermore, he said a potential recession, which would lower revenue, could widen the U.S. fiscal deficit potentially to $3 trillion. Gundlach said he thinks Treasury yields will go up in the next recession, and that he recommends avoiding longer-term bonds. His suggestion: Stay in two-, three-, and five-year U.S. Treasury notes.

A historically safe asset has gotten riskier

Remember, bond prices and yields have an inverse relationship, so when bond prices fall, yields rise, and vice versa. When a bond offers buyers a higher yield, holders collect more in interest, but generally, they're also accepting a greater risk that the issuer will default, leaving them unable to fully recoup their principal. U.S. Treasuries have always been viewed as safe-haven assets.

However, the country's growing debt presents the remote risk of the government not being able to cover all of the debt it has already taken on. Interest payments on the national debt consume a growing portion of the annual budget. If bond investors start to sniff out issues, they are going to demand higher returns to accept those risks, which could send yields soaring. In a recent analysis, ratings agency Moody's also cited the waning fiscal situation, and analysts haven't ruled out the agency lowering its credit rating on the federal government, which Standard & Poor's did for the first time in 2011.

Concerns about financial risks can become self-fulfilling prophecies. If there is even a slight inkling that an asset or institution whose chief value is its safety is not in fact safe, many investors will shun it.

Consider, for example, the regional bank crisis in 2023. As account holders at certain institutions like Silicon Valley Bank began to worry that there was a chance that those banks could go under and they wouldn't get their deposits back, they pulled their money out, intensifying the crisis and pushing the banks into insolvency.

All forms of lending are a matter of confidence. So, I would say there is a remote possibility that there could be an issue with longer-term Treasuries down the line if the government doesn't get its house in order, and remedying such a big debt pile will not be easy. It's more likely than not that Washington will keep up with its obligations, but then again, why take the risk on what's supposed to be a bulletproof fixed-income asset if you aren't sure that's what it is?

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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Moody's. The Motley Fool has a disclosure policy.