By Ian Salisbury

Bond markets so far appear to be shrugging off President Donald Trump's tariffs. Investors may want to prepare for tariff-related volatility by looking at international bonds that may provide better value.

The Trump administration rocked markets earlier this month when Trump issued, then temporarily rescinded, hefty new tariffs against Canada and Mexico, and imposed additional 10% tariffs on China. This week, the White House was at it again, announcing a motion for 25% import levies on aluminum and steel.

Bond investors don't seem fazed. So-called junk bond spreads -- which reflect the extra income investors demand from the lowest-rated corporate bonds relative to Treasuries -- are at their narrowest in a decade. Junk bond yields tend to be highly sensitive to interest rates and to the health of the U.S. economy. Narrow spreads suggest investors remain bullish.

"U.S. high-yield corporate spreads remain well below their 2019 trade-war levels, an optimistic sign from this risk-wary market," writes DataTrek Research co-founder Nicholas Colas.

There's a similar picture in the investment-grade world, according to BoA Securities. "Bond spreads have remained remarkably stable over the past two months," the firm wrote in a note last week. "Either risks need to moderate or spreads need to widen."

Complacency could end up costing bond investors. Tariffs, by their nature, tend to raise prices for consumers. Those inflationary pressures would make it harder for the Federal Reserve to justify additional interest rate cuts. (Bond prices and interest rates move in opposite directions.) Speaking before Congress on Tuesday, Fed Chairman Jerome Powell urged caution about further rate cuts, while adding that free trade "still makes sense."

Tariffs also add uncertainty to the market as investors try to handicap which industries will be hit the hardest. Automakers like General Motors, Ford Motor, and Stellantis all face significant risk, according to a note by credit researchers at Janus Henderson, as do computer hardware makers like Dell Technologies and HP Inc.

What should investors do? Tight spreads mean credit investors can't count on a lot of extra yield to offset declines in bond prices if interest rates rise, notes Gibson Smith, founder of Smith Capital Investors.

A partial solution is to shift your portfolio toward longer-term bonds, which offer extra yield and can be less sensitive to tariff-related inflation worries. "Owning some duration to protect against volatility makes a lot of sense today. Especially when policy risks are high," Smith writes.

Investors should also consider looking outside the U.S., according to bond giant Pimco. While the Fed has been cautious about rate cuts in 2025, foreign central banks could issue significant cuts, giving those countries' bonds a tailwind, says Marc Seidner, co-manager of the Pimco Dynamic Bond Fund.

Seidner says the U.K. and Australia are among the nations offering attractive value right now. Investors looking for a broad, simple approach can use an index fund like Vanguard Total International Bond Fund.

Write to Ian Salisbury at ian.salisbury@barrons.com

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February 12, 2025 02:00 ET (07:00 GMT)

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