By Matt Peterson

"The bond market is very tricky," President Donald Trump said in the wake of his announcement that he would pause some tariffs for 90 days. "I was watching it. But if you look at it now, it's beautiful."

That beautiful market, which suffered distress as yields were whipsawed earlier in the week, may still be in trouble, along with the president's continuing tariff plans. The bond market's reaction to the tariffs has alarmed investors and sparked fears of an incipient financial crisis as the tariffs went into effect. The immediate crisis may have eased, but with long-term Treasury yields still elevated, the problems that forced the administration to alter its plans on Wednesday could easily recur if the White House keeps moving forward with tariffs.

The stock market's jubilant reaction to news of the tariff pause quickly gave way to difficult new questions. Some in the bond market believed the Treasury Department wasn't in control of the situation, while the White House itself was unprepared for the market volatility. To people both inside and outside the administration, a dangerous situation appeared to have nearly gotten out of hand.

Trump's tariff policy -- the centerpiece of his economic strategy -- now has a counterweight that will be difficult for the president to ignore. The market knows it, and so does China, with its hundreds of billions worth of Treasury holdings.

The selloff in bonds -- which move inversely to yields -- amounts to a decline in confidence in the U.S. itself.

The $28.6 trillion U.S. Treasury market is the lifeblood of the global financial system. Central banks and private financial institutions around the world hold Treasuries of all maturities in huge quantities, and short-term Treasury debt is treated like cash. A rise in long-term Treasury yields puts pressure on the real economy by raising the costs of business and consumer debt, including mortgages and car loans.

Trump's tariff policy has pushed the Treasury market outside of investors' comfort zone, as evidenced by rapidly rising long-term yields and a sharp deterioration in liquidity.

Trump announced the tariffs on April 2. The scale of the tariffs took investors by surprise and the ensuing selloff in stocks and bonds caught the White House off-guard. From the time of the tariff announcement on April 2 through the pause on Wednesday, the S&P 500 stock index fell 12.2%, along with other stock indexes. The 10-year Treasury yield rose a quarter of a percentage point, while the 30-year yield rose by a third of a point in the same period -- jarring moves for bond yields in a short span. On Monday, an auction for three-year Treasuries went poorly, adding to investor concerns.

Hedge funds that had anticipated looser regulation would lift stocks found themselves forced to unwind their positions when stocks fell instead. Funds that were routinely making highly leveraged trades involving Treasuries and Treasury futures had to exit the market. Swap spreads -- the difference between the price of those assets and their derivatives -- widened abruptly. That indicated a deterioration in liquidity; suddenly, the market had only sellers. Those conditions have previously led the Federal Reserve, under other circumstances, to intervene to add liquidity.

Tariffs went into effect the morning of April 9. Former Treasury Secretary and Harvard Economist Larry Summers warned of the potential for a "serious financial crisis wholly induced by U.S. government tariff policy." Investors started to feel anxious about what would normally be a routine auction for 10-year Treasuries. Stocks briefly popped when the auction went well, and they went positively stratospheric 18 minutes later when Trump announced his tariff pause. The concerning signs in swap spreads also immediately eased.

The unfolding bond-market problems, and concerns about the 10-year auction, contributed to the president's decision to pull back on the tariffs, a White House official said on condition of anonymity. "Some administration officials were worried, and that created a sense of urgency. However, in the end, it turned out not to matter because the auction went so well," the official said.

The fallout from the episode may not pass that easily. A bond investor who deals regularly with the Treasury Department said that, behind the scenes, it wasn't clear the administration was in control of the situation. He worries about lasting damage to confidence in the U.S. financial system. "There's a skeleton crew at Treasury," he said, speaking anonymously to preserve his job and his relationship with the administration.

The Treasury Department has lost senior staff in the recent DOGE efficiency drive, and the investor said that the people left in Treasury jobs were less experienced. In addition, the chair of the Securities and Exchange Commission was confirmed only Wednesday evening, while the chair of the Commodity Futures Trading Commission is pending. Both are senior officials who normally deal with financial stability issues.

A dizzying array of tariffs also remains. Tariffs on China, which exported more than $400 billion in goods to the U.S. last year, are at a punishing 145%. Virtually all other countries face at least a 10% tariff despite the pause. The overall tariff level will rise to an effective rate of 25%, according to the Yale Budget Lab, the highest level since 1934. Negotiations may lower that level.

The economic hit is coming, said Mark Blyth, professor of international economics at Brown University. "We haven't begun to feel these effects. We're working on anticipations of what this is going to feel like. Wait until stuff in Walmart goes up five times," he said. (Actual price increases remain to be seen, although they could be hefty. The Yale Budget lab's model indicates the post-pause tariff package would cost the average family $2,700 in lost purchasing power.)

The administration has unleashed changes that may be impossible to unwind. Investors continue to implicitly question the strength of the U.S. economy by selling off the dollar. A dollar index that measures the dollar against a basket of other currencies has fallen for seven of the past 10 trading days and fell another 1.7% Thursday.

"I don't see anything unusual today," Treasury Secretary Scott Bessent said at a cabinet meeting Thursday. (The Treasury didn't respond to requests for comment.)

"You've really got a fragile market structure with a lot of pockets of leverage. All this depends on the Treasury not being questioned," Blyth said. Ultimately that will mean a higher premium because investors will say, "I don't trust the people in charge."

Rising long-term Treasury yields show skepticism in action.

Republicans this week endorsed a budget plan that will add trillions to the deficit, while tariffs have raised recession fears. "During a recession, the deficit can go up anywhere from two to six percentage points," said Michael Medeiros, a macro strategist with Wellington Management. "The context matters." Rising deficits mean issuing a greater supply of debt as investors' appetite for it is already in question.

Investors may snap it up. A 30-year Treasury auction on Thursday went well, just like the 10-year auction the day before. But the administration will soon learn that these auctions, coming relentlessly week after week, will be fraught until successfully completed. Many eyes are now on each one. Having caved to the bond market, Trump and his Treasury secretary may well face pressure again from the infamous bond vigilantes. Bessent would know; his market renown stems from his time with investor George Soros shorting the U.K. pound in 1992.

But in 2025, the administration's tariff agenda is in limbo. After Wednesday's post-pause euphoria, stocks resumed their weeklong selloff. Swap spreads started to widen again, and the dollar continued to slide. The lasting lesson of this episode may be a familiar one. Confidence, once lost, is hard to win back.

Write to Matt Peterson at matt.peterson@dowjones.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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April 10, 2025 18:10 ET (22:10 GMT)

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