The Bond Market Has Struggled Since 'Liberation Day' Tariffs, but the Fed is Not Rushing to Cut Interest Rates

The U.S. bond market has faced ongoing challenges since former President Donald Trump introduced his “liberation day” tariffs, while Federal Reserve Chair Jerome Powell has shown little urgency to lower interest rates amid trade-related uncertainty. These large tariffs, announced on April 2, created turbulence across financial markets, especially in fixed income, as investors worried about the broader economic consequences.

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Since the tariffs were introduced, market volatility has remained elevated, and riskier areas of the bond market—such as high-yield corporate debt and long-dated Treasurys—have performed worse than safer investment-grade bonds. During an appearance at the Economic Club of Chicago, Powell acknowledged that the scale of the tariffs had exceeded the Federal Reserve’s expectations, even surpassing what it had modeled in its more aggressive scenarios.

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Investors are particularly concerned that tariffs could weigh on economic growth while simultaneously boosting inflation—a combination that presents a difficult challenge for monetary policy.

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Hopes have been pinned on possible negotiations between the U.S. and its trade partners that could result in reduced tariffs. However, China’s retaliatory measures after the U.S. announcement only heightened tensions, particularly between the world’s two largest economies.

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At the Chicago event, Powell described the bond market as navigating “historically unique developments” in an atmosphere of “great uncertainty.” He predicted that volatility would likely continue in the near term.

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Exchange-traded funds (ETFs) focused on corporate bonds have struggled in recent weeks. This includes both investment-grade and high-yield categories, the latter of which carry more risk and are often referred to as “junk” bonds due to their lower credit ratings. The SPDR Bloomberg High Yield Bond ETF (JNK), which follows an index of U.S. junk bonds, fell about 1.6% from April 2 despite a modest rebound later. On a total return basis, the fund was down 0.2% for the year.

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One unusual development has been the simultaneous rise in Treasury yields and widening of credit spreads—the extra yield investors demand for holding corporate debt over U.S. government bonds. Normally, in times of market stress, investors flee to the safety of Treasurys, pushing those yields down, while credit spreads widen. The recent moves broke from that pattern, according to Chris Alwine, global head of credit at Vanguard. He noted that in a typical “risk-off” environment, Treasury yields and credit spreads are negatively correlated.

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The spread between corporate and Treasury bond yields jumped after April 2 but began to narrow again after Trump paused some tariff plans on April 9. Even so, yields on benchmark Treasurys have remained volatile. For instance, the yield on the 10-year Treasury note experienced its largest weekly gain since 2001 before easing slightly, closing Thursday at 4.325%.

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The climb in long-term Treasury yields, despite the presence of risk-off sentiment in other parts of the market, led analysts to consider various possible causes. Some suspected that foreign holders of U.S. debt might be offloading their Treasury positions. Others pointed to hedge funds unwinding leveraged bond trades as a factor behind the sharp moves.

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Powell acknowledged the difficulty in determining what’s really driving bond market fluctuations in real time. “It’s very premature to say exactly what’s going on,” he remarked, although he did recognize that some hedge fund deleveraging appeared to be taking place. Nevertheless, Powell described the bond market as functioning in an “orderly” manner, given the high level of uncertainty.

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Broad bond market benchmarks have also taken a hit. The iShares Core U.S. Aggregate Bond ETF (AGG), which holds a diversified mix of Treasurys, mortgages, and investment-grade corporate bonds, lost about 1% between April 2 and Thursday. However, it's still up 2% on a year-to-date basis.

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Meanwhile, funds holding long-duration Treasurys have suffered more. The Vanguard Long-Term Treasury ETF (VGLT) has declined roughly 3.8% since April 2.

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Investment-grade corporate bond funds have also been negatively impacted. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) dropped 2% during that same period. Yet, despite recent losses, it has delivered a 1% gain for the year.

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Looking ahead, Alwine warned that high-yield bonds could continue to underperform if economic growth falters. He noted that Vanguard has maintained a cautious stance toward the high-yield sector, not because of deteriorating fundamentals, but due to rich valuations. Earlier in the year, junk bond spreads were historically tight, increasing their vulnerability to external shocks.

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As for monetary policy, Powell gave no indication that the Fed was preparing to cut interest rates soon. He emphasized that the central bank was “well positioned to wait for greater clarity” before making any changes. Powell said the U.S. labor market remains strong, and while inflation has come down from its 2022 peak, it still remains above the Fed’s 2% target.

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He acknowledged that the Biden administration’s significant shifts in trade policy could make it harder for the Fed to achieve its goals of stable prices and full employment. For now, the Fed is taking a wait-and-see approach as it tries to evaluate the long-term implications of current trade dynamics.

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Powell concluded by warning that tariffs would likely cause at least a temporary spike in inflation. The longer-term impact will depend on how extensive those price increases are, how fast they filter through the economy, and whether inflation expectations remain anchored over time.

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