When the bond market goes bonkers, so does the Dollar

Before launching into today’s ideas about the bond market, we want to warn of a potential political development that can change the whole landscape. It’s the fight between Musk and trade advisor Navarro, the guy who invented all this bad-economics tariff junk. Musk called Navarro a moron and said “Navarro is dumber than a sack of bricks,” among other insults.

The White House brushed it off but were Musk to press the issue, there is little doubt about which guy would win—and it’s not the loopy economist but rather the guy who gave Trump hundreds of millions of dollars. The mainstream press is not putting the feud on the front page, but cable newscaster O;Donnell says Musk will win, Navarro will be fired, and the tariffs will go away or be adjusted dramatically downward. This could be within days or months but within a year.

As with all political predictions, apply a cup of salt. It’s true that Musk has lost billions in the stock market upheaval of tariffs. It’s also true that Navarro is just plain wrong about tariffs. And while Trump is a stubborn 4-year old, he likes getting Musk’s money and dislikes being haled over the coals by his top contributor and by Wall Street. Therefore, the probability is not small that O’Connell is right.

To that we can add that Congressional Republicans are hearing from the voters in their districts and starting to form a backing for reining in Trump on tariffs. This would be an intolerable punch in the face for Trump, so while we can’t expect an overthrow, we can expect exceptions and exemptions galore. Remember that the Republicans are the free-trade party so the hypocrisy will not go unnoticed. The WSJ writes “They’d better find their old convictions soon.”

The gyrating bond market is the top headline everywhere today. There is a single bottom line—Trump has wrecked the US’ safe-haven status.

It’s not always true and it’s hardly ever true down to the last pip, but the dollar is tightly correlated with the 10-year bond. When the bond market goes bonkers, so does the dollar, as we have just seen.

The gyrations in the bond market prices/yields are cause for concern. Nobody actually knows who is doing the buying and selling, although one analysts says the basis trade could be behind some of it. This is selling over-priced bond futures while buying the actual bonds and dumping the futures when the prices converge (as futures prices MUST do). It can be high leverage for the futures, so plenty risky. Both Barrons and the excellent Matt Levine wrote about the basis trade today.

The point is that we don’t know who is selling and driving yields down, nor who reversed course and drove yields the other way on Monday and Tuesday. We asked some experienced bond traders and they are at a loss, too. One said “something is up” and pointed out that people sell stuff in order to get the cash to meet margin calls.

The WSJ says “Bond traders appear to be betting on a return to normal before long.” This is doubtful. Bond traders are smarter than that.

WSJ: “The answer may be that bond traders are reflexively pricing in the simplest scenario—a short-term economic shock followed by a rapid return to the status quo. Bonds are also being pulled in two different directions: fears of a recession are mounting, but tariffs raise the prospect of higher or stickier inflation.” That implies traders changing their mind every 12 hours, also not realistic.

The analysis points out the big disconnect between the short-term outlook and its associated Treasuries, and the long-term outlook.  “… it is more likely that traders have given up on predicting long-term economic growth given the current chaos.”

Then there’s ”other forces at play” like blaming foreigners for exiting bonds, but that implies it was domestic buyers on the rise in the past few days. Not to be ditzy, but ”other players” has to include Russia and China, maybe even Iran. You have to wonder if the newly gutted national security guys are asking for client info from the banks and brokers. No, they are not smart enough.

China has literally trillions in US Treasuries of varying maturities and can sow disruption left and right. Sell some and get the price up for no reason at all. Buy some back and drive the yield down, also for no reason at all except to disrupt the market and confuse the hell out of everybody so they give up and stash their money under the floorboards.

Brown Brothers writes that “The idea that China can weaponize its US$700bn stash of Treasuries in a trade war with the US does not pass the smell test. China holds less than 5% of the total outstanding amount of long-term Treasury securities which is too small to have a meaningful impact on Treasury yields.” Really? We don’t argue with former employer Brown Bros, but $700 billion is plenty to stir up a volatility storm. If the goal is to drive investors from the stock and bond markets into plain old cash, it’s working.

Why do that? To end the dollar’s stranglehold as the numeriaire for trade and reserve currency. Trump is giving China exactly what it wants to damage US hefgemony.

Reuter takes a stab at the conundrum, too, pointing out that “it's notable that even though the benchmark yield has declined 60 basis points since January, it is still 60 bps above its September low. Or, looked at another way, although the S&P 500 has fallen 17% in the last five months, losing around $9 trillion in market cap, the 10-year yield is essentially unchanged.

“You can always pick and choose your timeframe to suit a narrative, but it is clear that yields are not falling as much as Bessent and Trump would like, or as most observers would expect in such a febrile 'risk off' environment. Treasuries are simply not attracting the 'flight to safety' demand from global investors, as they have in almost every period of stock market turbulence in recent decades.

We care about this because the correlation between the Treasury yield and the dollar is, most of the time, pretty tight. Both the bond and FX markets view the macro data pretty much the same way. That is well-focused on whether the Fed cuts by some 75 bp to year-end to fend off recession, or throws the glove down in front of Trump and raises rates to curb inflation. Raising rates would draw Trump’s ire and drive him to fire Powell and put his lackies on the Fed Board. Doing nothing is only to push out the day of reckoning.

Food for thought: What comes next? It all depends on whether this is going to end up as an unforced error/self-destruction or the feedback loop is crooked enough to sling outcomes in a different direction than what we foresee now. In other words, it will take folks outside the White House, from inside the US or outside, to shift the narrative. This is different from what Trump thinks he wants, subservient vassals bowing to the king.

Congress takes away Trump’s “emergency” power he is using for tariffs.

The Supreme Court rules on various issues against Trump.

Several countries band together to flatter and bribe. 

Canada halts all critical exports and forces a showdown.

Businesses and Wall Street gang up on Trump and also tell Congressional Republicans they will withhold primary money to ensure they lose the next election.

Protests in the US grow and grow and grow., cutting T’s approval rating to under 20%.

Forecast

The tariff problem has now reached catastrophic proportions and it’s hard to see how it can persist very much longer. Actually, it can persist as long as Trump stays stubborn. We have to expect that at some point the dam will break and conditions will change. The start could be Japan getting a deal, implying Trump was really just “negotiating” all along. If this idea catches on, the devil uncertainty falls back. The dollar can recover, again. Unless and until we see a chink in the armor, the dollar is toast.

Tidbit: It’s not just the tariffs that are damaging the US reputation for sane and reasonable leadership. It’s also the stupid changes being made elsewhere, like Social Security. DOGE backed off closing all those offices targeted, but then installed a website that doesn’t work. Anti-Vax Kennedy attended the funeral of a girl who died of measles and spoke with forked tongue—measles vaccine is good but alternative medicines are good, too (they’re not). Cod liver oil does not cure measles.

Krugman calls this the “quack industrial complex” and it extends to closing down critical research on pandemic-potential viruses, cancers, etc. plus promoting the end of water fluoridation. Krugman writes “Medical snake oil plays a surprisingly large role in right-wing extremism. Right-wing influencers gain audiences by peddling hatred. But they monetize that hatred largely by selling fake remedies and nutritional supplements. So it’s not surprising, if you think about it, that a right-wing extremist administration has put quacks and snake-oil salesmen in charge of the nation’s health care.

“Did I mention that Dr. Oz has been appointed to run Medicare and Medicaid?”

We take it further. It’s not just the upcoming unnecessary illnesses and deaths or the loss of respect for the US. It’s a sea change in the form of disrespecting science. Respecting science has been a linchpin of American progress. We embraced the photograph, the light bulb, the radio, the car, the railroad, the transistor, and on and on. We also embraced penicillin (that vanquished tuberculosis), insulin, the polio vaccine, the tetanus shot, etc.

It may take only a few years to restore the agencies Trump is tearing down. We may never recover from anti-science. The number of climate change deniers could grow from 14.8% now to a number big enough to tear down the windmills and solar panels. Clean energy is about 21% of US power generation. Globally, it’s higher at about 30%. What if the US backslides? The US accounts for only about 16% of global energy consumption, but that’s still a huge number.

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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