Two weeks ago, President Donald Trump confidently announced his long-awaited reciprocal tariffs in a widely viewed Rose Garden address. Essentially unchecked by members of his own party and appearing more confident than ever, the president imposed steep tariffs on allies and adversaries alike. Even a sinking stock market couldn’t convince President Trump to pause his tariffs. Then the bond market forced him to fold.
Last week brought a frenzied trading session in the bond markets as investors dumped bonds overnight—sending the 30-year Treasury yield briefly above 5 percent. To put this in context, the annual change in market yield is often less than the two-day change of 65 bps the market experienced last week.
The next morning, President Trump unilaterally paused for 90 days the implementation of some of the historic tariffs imposed on our trading partners.
“I was watching the bond market. I saw last night where people were getting a little queasy,” President Trump admitted. “Over the last few days, it looked pretty glum—to, I guess they say it was the biggest day in financial history. That’s a pretty big change.”
Trump’s concern was warranted—a shock recession with prolonged slower economic growth would end his presidency overnight and have long-lasting economic repercussions, including a debt spiral. The bond market sent a warning shot and Trump responded accordingly.
Buyers purchase bonds with the expectation of a stream of interest payments plus principal repayment at the end of the term. Once someone purchases a bond, he is free to sell this asset on the open market. The price received will decline as interest rates rise overall; after all, why would someone pay face value for the right to receive, say, 3 percent interest payments per year on a bond if he could purchase another newly issued bond at 4 percent or 5 percent? To account for an increase in interest rates, the price of the existing bond will decline.
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The recent decline in the price of bonds reflects that investors are demanding higher interest rates on newer bonds. That indicates two concerns are at play: (1) that inflation will heat up in the longer term, eroding the future value of the promised payments and (2) that interest rates on newly issued bonds will increase. Both concerns are well-founded.
Interest on the federal debt for the first half of this fiscal year set a record at $582 billion. The average interest rate on federal debt has doubled since 2021. Higher interest rates on a much higher balance owed means the government must incur more debt to cover interest payments. With government spending growth exceeding revenue growth, this additional interest expense must be covered by issuing (selling) yet more debt.
Government spending continues to surge. Federal spending today is 7.3 percent higher than it was one year ago—rising faster than inflation plus population growth. With Congress showing little appetite to enact meaningful spending cuts—despite the DOGE excitement among the grassroots—spending is likely to rise faster than revenue in the coming years. This will create the need for Treasury to issue more government bonds to pay the bills. Higher interest rates may be needed to encourage investors to purchase these bonds.
Trump’s tariff plans sent a jolt to an already jittery bond market, causing Asian buyers to dump their treasuries. This selloff further threatened to undermine the federal government’s ability to pay its debts. Full implementation will undoubtedly slow economic growth—perhaps sparking a severe recession.
The stock market’s decline reflected investor fears that income and dividends would be hampered by a tariff-induced recession. Even at a 10 percent rate, tariffs will have a prolonged impact on the federal budget due to lower economic output than previously estimated. A widening of the federal deficit will force the Treasury to issue more bonds at higher prices to attract investors.
The bond market did what no presidential advisor or political pundit could do—it forced President Trump to fold on his tariff strategy. The current crisis is entirely self-inflicted by a sophomoric tariff policy. To restore the calm necessary for economic growth, the president should embrace free trade with free nations and end the trade war.
Marc Short is Chairman of Advancing American Freedom and former Chief of Staff to Vice President Mike Pence. Joel Griffith is a senior fellow at Advancing American Freedom.
The views expressed in this article are the writers’ own.
