Markets and investors scarred as long-term US borrowing costs set for biggest spike since 1980s

With the US-China trade war continuing to escalate and rampant uncertainty around the possible impact of Trump’s tariffs on economic growth, equity markets continue to suffer volatility. The FTSE 100 Index was up about 0.5% late morning Friday, after a 3.46% fall in the S&P 500 on Wall Street overnight.

Here Edward Park, Chief Asset Management Officer at wealth management firm Evelyn Partners, assesses the prospects for the global economy and financial markets after Trump’s tariffs pause. 

Only Trump knows what prompted this week’s reversal, although it has been suggested that the sharp sell-off at the long end of the US bond yield curve played a role, with the administration said to be concerned about broader risks to the global financial system. 

While this represents good news relative to Liberation Day, the 10% baseline tariffs imposed on all global trading partners still represents a significant increase in tariffs. There remains scope for an increase to this baseline tariff for some countries depending on how negotiations go with the US administration, which means that uncertainty will continue to hang over businesses. 

Moreover, tensions between the US and China escalated as Trump imposed a 125%, later confirmed to be 145%, tariff on China - to which China has now retaliated. Now, we believe the market is looking at three possible scenarios.

The first, and most pessimistic possibility, is that the Trump administration is entirely fixated on seeing a US manufacturing renaissance. This sees a scenario where there is virtually no room for negotiation and where the economic and market pain from Liberation Day are viewed as necessary for global manufacturing to be onshored back to the US. 

The resulting elevated tariffs risk robust responses from other countries which ultimately leads to a spiral of protectionism which in turn leads to a high likelihood of a recession and far more pain for equities.

The more positive outcome is that trade deals are quickly made across the board with all the tariffs announced on 2nd April, including the 10% baseline tariffs, removed amid a grand global trade deal or series of major deals with trade partners. This scenario would lead to a broad rally in equity markets although there would still likely be some equity and bond market damage from the legacy of policy unpredictability.

It is our base case however that appears to be most likely in the wake of Wednesday’s announcement, or more cynically is now the plan given the market turmoil. This scenario sees the tariffs as a tool designed to bring countries to the negotiating table, with the Trump administration seeking to focus the worst of the tariffs on a small number of trade partners who retaliate. While this is clearly better news than the worst-case scenario, and was enough to prompt a market rally late on Wednesday, this still leads to higher inflation and lower economic growth than before Liberation Day.

What does this therefore mean for our view of the world looking ahead?

Our base case for 2025 now sees higher inflation and lower growth than we expected at the start of the year. We expect economic growth to still be positive for the year but for it to be lower now that consumers and businesses must contend with the major uncertainty of global tariffs. Despite the pause in the enhanced tariffs, the baseline 10% global tariffs remain and this will have an inflationary consequence, making the 2% inflation targets for the Federal Reserve and Bank of England look tricky to manage.

So, while markets have improved since Wednesday, uncertainty persists and stress remains, firstly in the bond market. 

Arguably the main reason why Donald Trump reversed course over the enhanced tariffs is the increasing funding cost for the substantial US debt burden, demonstrated in the left-hand graph above as the yield of the US 30-year Treasury. As we saw in the UK during and after the Liz Truss mini-budget crisis, the rising cost of long-term debt can quickly have political consequences. 

Despite the reversal of the enhanced tariffs, the 30-year US government funding costs remain very high, this suggests that global investors now require a higher yield to compensate them for the severe uncertainty created by the last week. 

This is bad news for the US government which has a large deficit and therefore requires investors to buy their bonds to finance day-to-day spending. It is also bad news for consumers who need to fund mortgages and companies that need to fund long term debt. As of close of business yesterday the 30-year US bond yield was on course for an almost 0.5% increase this week, the largest rise since the 1980s.

The right-hand graph above shows that expectations for US interest rate cuts have largely returned to where they were before 2 April but scarring remains in the US bond market.

Crucially, even with the partial reversal announced this week, the aggregate level of US global trade tariffs is still expected to surge to levels not seen since the 1930s:

And this will keep the US equity fear index, shown on the right-hand side, elevated. This fear index shows the level of volatility in the market but another lens is the statistic that yesterday was the remarkable fifth day in a row where the US equity market traded within an intra-day range of more than 6%. Moves that underline the uncertainty in markets.

However, history tells us diversification can help us weather times of crisis and at Evelyn Partners we build portfolios to weather a range of scenarios. This is exactly why we consider what would happen if the market’s base case does not unfold as expected. Thoughtful portfolio construction and considered scenario analysis allows us to build resilient portfolios.

This chart shows previous market crises and demonstrates that even in a sharp equity sell-off, bonds and alternative assets can provide a ballast to portfolios: