Great turmoil, great situation – to use a phrase from former Chinese President Mao Zedong to sum up the trade war declared by President Trump. The dollar extended its biggest plunge in three years on Friday, April 11, after China raised tariffs on U.S. goods to 125% from 84%, a step up in tensions that sent gold soaring, markets everywhere reeling and investors more uncertain than ever about the global economic and financial outlook.
Interesting times with opportunities for gains and risks for losses – for those who can stand it. The Trump 2.0 administration has famously raised its own tariffs, now to 145%, on Asia’s largest economy. Trump, after all, has previously threatened to impose a 200% tariff on certain Chinese products.
Perhaps most interesting this week is what global investors learned about Trump 2.0’s pain threshold: he is willing to take epic losses in the stock market, but not indicative signs of discomfort in the bond market.
Later events will show that it was not the US Congress, the judiciary or voters who forced the US president into a more transactional tariff policy. It was investors in US debt.
In Asian trading hours on April 9, the so-called “punishers of the bond market” pushed the yield on 30-year US Treasury bonds above 5%. That—and memories of events from the mid-1990s, the mid-2000s, and the collapse of Silicon Valley Bank in 2023—led Donald Trump to decide on a 90-day tariff suspension. However, concerns about the next round of bond market bloodshed for the White House are coming from Asian central banks.
Central banks in the region hold about $3 trillion in U.S. bonds, with Japan and China, the top holders, holding a combined $1.9 trillion.
If they were to start selling on a significant scale, who could stem the tide of U.S. debt? Except for the world’s biggest banks, which are buying steadily, arguably no one. That’s why rumors in bond trading this week that Japan, China and other Asian monetary authorities might sell have alarmed top U.S. Treasury officials.
For years, investors have feared that China could dump a large bundle of U.S. bonds in retaliation for U.S. sanctions and restrictions. That day may have arrived.
Refinancing $7.5 trillion in debt
China, after all, has an incentive to show that it “will not hesitate to cause turmoil in global financial markets in order to improve its bargaining power against the United States.”
Trump’s tariffs and other policies could alienate bond buyers, which risks raising borrowing costs when the United States has to refinance about $7.5 trillion in coupons over the next three years.
Treasury Secretary Scott Bessent’s years working in hedge fund circles were useful in understanding current events. A crash like that of Long-Term Capital Management (LTCM) could have been devastating for global markets and the U.S. economy. LTCM’s collapse in 1998 was partly due to rising debt yields.
A repeat of the scenario in 2025, with Trump’s tariffs upending all asset classes and China flirting with deflation, could make the 2008 Lehman Brothers crash seem like just another day at the office!
But the risk that Trump’s policies could drive Asian central banks out of the U.S. debt market is growing by the day. That threat provides a unique leverage point for the Bank of Japan, the People’s Bank of China, and other leading Asian monetary authorities.
Asia’s main leverage over Washington right now is through bonds, currencies, and trade in services. The latter category refers to America’s deep dependence on Asian markets for exports of financial services, technology, and intellectual property.
The “mechanics” of Trump’s tariff-laden trade war suggest an incomplete understanding of the vulnerabilities of the U.S. economy relative to Asia. Bond investors, the types who take matters into their own hands when a government’s policy mix seems misguided, are found across the debt and currency spectrum.
The bond market punishers have struck again. As far as we can tell, at least in U.S. financial markets, there are only about 1,000 players involved. Although “equity punishers” were clearly telling President Donald Trump that his tariff policy was wrong late last week, his advisers argued that falling oil prices and bond yields were ultimately helping Main Street. That changed as the 10-year yield rose.
If fiscal and monetary authorities don’t regulate the economy, bond investors will. The economy is and will be run by financial markets.
A decade later, James Carville, then an adviser to US President Bill Clinton, made his famous remark about how he would like to be reincarnated as a bond market. “That way, you can scare everyone,” he said wryly.
This came back to haunt him during the balanced budget negotiations. At the time, debt investors were hypersensitive to the slightest hint, good or bad, of the zigzags and zags in Washington’s fiscal policy discussions.
Today, as the US national debt nears $37 trillion, Asia has very good reason to be concerned about Washington’s fiscal health. The Republican Party, for example, is seeking another multi-trillion-dollar tax cut that could accelerate the national debt to $40 trillion.
At the same time, the situation in Congress is forcing senators to engage in a political battle over the debt ceiling and fund the government at even greater rates than in 2011, the year S&P Global Ratings downgraded Washington’s AAA credit rating.
This market-shaking move came two years after then-Chinese Premier Wen Jiabao expressed concern about Washington’s ability to safeguard China’s vast dollar-denominated state wealth. Wen was particularly concerned about the scale of the bailouts amid the Lehman Brothers crisis.
“We have provided a huge amount of loans to the United States,” Wen said in 2009. “Of course, we are concerned about the safety of our assets. To be honest, I am a little concerned.” He urged Washington to “honor its agreements, remain a trustworthy nation, and ensure the safety of Chinese assets.”
At the time, U.S. debt was less than $12 trillion, two and a half times lower than when Fitch Ratings downgraded the U.S. in 2023. Today, Moody’s Investors Service is considering whether to maintain Washington’s latest AAA rating with U.S. debt three times higher than in 2009. There are long-term fears that the government of Chinese leader Xi Jinping could dump dollars in retaliation against Trump’s tariffs, now at 145% after a series of escalations.
It would be a Pyrrhic victory, of course. Any increase in borrowing costs would backfire China’s way, as U.S. households would suddenly consume fewer Chinese goods. Nor would it be in Beijing’s interest if global investors decided that the U.S. budget deficit would look like an impending slow-motion train wreck.
The potential contagion effects could make the Lehman Brothers crisis of 2008 look like a school trip. Even so, Xi’s Communist Party may have calculated that the U.S. has much more to lose in the event of a Global Financial Crisis 2.0. If China were to pull the plug now, it would find U.S. markets decidedly out of balance, amplifying the impact.
In 1997, then-Japanese Prime Minister Ryutaro Hashimoto admitted that “several times in the past we have been tempted to sell large amounts of U.S. bonds” to show our strength. One such episode occurred during the heated auto negotiations a few years earlier.
This time, the intrigue involves the Trump turmoil that is already in full swing. Investors in the fixed-income market may be starting to worry that the Chinese and other foreigners might start selling U.S. bonds. The bond market, he adds, is worried “the Trump administration might be playing with nitroglycerin…”
A blow to credibility
Count the ways this White House could damage the credibility of the dollar and the …sanctity of bonds, the cornerstone of global finance. They include:
- obsessing in an arms race on inflationary tariffs,
- interfering with the independence of the Federal Reserve,
- controlling the Internal Revenue Service, and
- pursuing trillions in new tax cuts that the US government believes the Asian bankers in Washington will steadily finance.
That last assumption is highly questionable given reports that Asian central banks are already reducing their exposure to the US. But watching Trump’s exploits—which could easily jeopardize America’s creditworthiness—from 7,000 miles away is causing serious concern among Asian policymakers.
One irony is that Asia is watching the Trump administration do many of the things the United States punished Asia for a quarter of a century ago. In 1997-98, when Hashimoto was scaring bond traders, American officials were advising Bangkok, Jakarta, Kuala Lumpur, Manila, and Seoul against oligarch-dominated financial systems and extreme opacity. Now it is Asia’s turn to watch Washington torch its once-famous financial institutions with astonishing speed.
For now, it appears that the damage Trump has inflicted on stocks may be less than it will be on debt. While stocks have rallied since Trump’s freeze, bond yields have not fully recovered from the sharp moves seen earlier this week, reflecting some potential damage to U.S. economic credibility.
The dollar continued to fall as well. The political fallout from this is potentially more widespread than any market decline, as higher yields make it harder for small businesses to access loans, with negative implications for the U.S. economy. The ways in which Trump is jeopardizing U.S. growth, as alarm bells ring about a possible recession, would normally cheer debt markets.
But given the inflationary impact of the tariffs, bond traders are taking a dim view of Trump’s p2.0 policies. Markets are concerned that the Trump administration has “arguably shown more tolerance for causing a recession than many might have thought.”
But the effects on the bond market are forcing the Trump team to back down. The question is when the biggest of the bond market’s punishers — the central banks — will start actively selling bonds. Japan and China are Washington’s biggest lenders, followed by the United Kingdom, Luxembourg, the Cayman Islands, Belgium, Canada, France, Ireland, Switzerland, Taiwan and Hong Kong.
If markets perceived that one of their central banks was either aggressively selling debt or simply halting new purchases, the result could be devastating for global credit markets. If Trump understands this risk, he needs to demonstrate it to the Asian central bankers who essentially hold the US economy in their hands.
