One week / one topic: Freedom is not free

What happened?

Since the April 2nd tariff announcements – bringing about the highest barriers to trade since the 1930s, even after the subsequent negotiations and exceptions – US stocks are up ~5%.

What?

To boot, this is all happening despite stretched stocks valuations and with many companies pulling guidance to reflect the massively more uncertain business environment and the first impact of price increases.

At the same time, 10yr bond yields have also increased by ~30 bps and are now almost exactly at the same level as when Treasury secretary Scott Bessent explained in early February that yields matter.

While his attempt was to rationalize the previous fall in yields as the bond market endorsing Trump’s policy goals of tax cuts and deregulation as conducive to non-inflationary growth, markets are now worried about the opposite outcome in the form of stagflation.

Add to the mix concerns about the upcoming ‘big and beautiful’ US tax bill negotiations – will it be just ‘a lot’, or an insane amount à la Liz Truss? – and you can craft a handy narrative as to why 10yr yields are back to ~4.5% and 30yr yields are not far from 5%.

And yet, shouldn’t Trump self-confessed constraint in the form of US Treasury yields represent a compelling asymmetric set up to remain long US duration?

(In the end, he did say on the record that “People were getting a little queasy… The bond market is very tricky” to contextualize the pause on ‘reciprocal tariffs’.)

In other words, if Trump blinked so quickly after his ‘historic’ Liberation Day tariff announcements… does it mean that there is an untenable pain threshold around 4.5% for 10yr yields?

Our observations

• Fundamentals: As noted many times before, the only item firmly in the Overton window is ‘more debt’… even as GDP has grown robustly for quite some time..

• Price action: The psychological anchoring of 4.5% and 5% on the 10yr and 30yr yield is there. Whether you like it or not, round number bias is a thing.

• Investor beliefs: Despite it all, hope for continued equity strength is palpable among longs while the pain trade for fundamentals-oriented investors remains higher prices. The jury is out…

So what?

US 10yr yields stand at ~4.45% as of today, or just above their average over the last 6 months.

If we project forward another six months from now, the table below shows 10yr US Treasuries’ forecasted total return for different yield levels.

Considering that over the past six months we have witnessed the aforementioned spike in trade tariffs and overall policy uncertainty – plus the alleged bursting of the ‘US exceptionalism’ bubble – the value proposition for US Treasuries still looks compelling.

Should an economic slowdown – or another, unforeseeable shock – take us down to 2.5% yields (roughly, the average over the last 10 years) the total return from a position in US 10yr Treasuries would be ~ 37%.

Conversely – should we explore 5% yields, a place we haven’t been to since the heady days of 2007 – the loss would be only -4.3% taking into account the carry on the position as well.

All in all – despite the recent pain of holding duration as a ballast vs the equities risk we hold in portfolios – diversification still seems like a sound proposition.

Should yields spike due to unanchored fiscal or issuance plans, we would also ultimately count on reflexivity, i.e. markets forcing US policymakers to change their tune if they want to keep selling debt – especially as foreign buyers are now significantly less inclined to warehouse USD risk. (The US was also just downgraded by Moody’s)

Every 0.01% increase in 10yr yields equates to an extra ~ $1 billion expense for the first-year budget… which can be dangerous in unpredictable ways when you’re running 7% deficits, ‘Art of the deal’ or not.

Mood music: Steppenwolf – Born To Be Wild