Why markets panicked
Trump had been telegraphing his intention to implement substantial tariffs for a long time and throughout his election campaign. Markets were already turning their attention to tariff risk as stocks began to slide in late February.
So why such a severe negative reaction to the Liberation Day announcement? The short answer is that the proposed rates were extremely high.
Trump’s interest in tariffs as a tool for economic policy is based on a wide range of goals.
Tariffs are seen as a way to protect American manufacturing, especially where national security interests are related (for example, military equipment). They are a potential source of revenue, which can help fund personal and corporate income tax cuts. They are also a bargaining chip to extract concessions from other countries on trade and in other arenas.
Investors generally do not like tariffs, however, because they are a source of economic friction and an impediment to economic growth.
From the perspective of many businesses, tariffs can be quite disruptive in that they can impact a company’s entire cost structure and business model, especially when tariff rates are unknown and subject to change.
On a more macro level, countries that engage in trade protectionism are disfavored by global investors. The U.S. has always attracted global capital as the standard bearer of free market capitalism.
Tariffs in the 10% to 15% range were generally anticipated going into Liberation Day. Even if investors were not enthusiastic about tariffs, this range was seen as manageable.
Stocks even drifted up in the after-market on the afternoon of the Liberation Day event as it momentarily appeared that tariffs would be limited to 10%.
Way too high
But what was proposed by Trump was far greater.
The floor was set at 10%, but then various countries, including major U.S. trading partners, would be assessed much higher tariffs based on a calculation that was linked to every country’s trade deficit with the U.S.
Investors essentially went apoplectic, including many Trump supporters.
Tariffs were in some cases set at such high levels that they effectively threatened to bring an end to trade with certain countries, like China, altogether.
Even if tariffs were seen as unlikely to land at such high levels after a negotiation process, the uncertainty meant many businesses would be frozen in their tracks.
The linkage of tariffs to trade deficits appears to have been the brainchild of Trump trade advisor Peter Navarro, who previously argued for this approach in The Case for Fair Trade. This particular method of formulating tariffs also disturbed markets.
Few economists beyond Navarro believe bilateral trade deficits are inherently indicative of abusive trade practices. The approach also appeared to leave limited room for high trade deficit countries, like Japan, to amend their behavior.
The market was actually somewhat warm to the idea of applying truly reciprocal tariffs because it could have created a dynamic that could lead to overall lower tariffs in the future.
This is perhaps similar to the idea of “peace through strength”—building up a country’s military capability to create a credible threat that ultimately prevents war from erupting.
For example, if a trading partner were applying 20% tariffs, and then the U.S. threatened to impose equivalent tariffs to match them, perhaps the ultimate outcome would be the elimination of tariffs altogether.
But if Trump was going with Navarro’s unusual definition of reciprocity (based on trade deficits), there was no apparent off-ramp. Many of these countries were already applying tariffs to a very minimal extent.
Treasuries go haywire
While stocks certainly reacted negatively to Liberation Day tariffs, the reaction of the bond market may have been even more impactful in terms of how the month played out.
Typically, in “risk off” scenarios, long-term U.S. Treasuries rally. For example, in early March 2020, the yield on 10-year Treasuries collapsed close to zero, getting as low as 0.3%.
Treasuries, which rise in value when interest rates fall, are generally sought after in economic crises because they offer stability.
Interest rate expectations also typically fall in these situations because investors expect slower (or even negative) economic growth, lower inflation (or potentially deflation), and rate cuts.
In the aftermath of Liberation Day, there was some speculation that the Trump administration was willing to accept some (presumably temporary) weakness in equity markets if it meant long-term Treasury yields would come down.
Lower long-term interest rates are an explicit goal of the administration. Low rates would be helpful in terms of refinancing maturing Treasury bonds as well as bringing down mortgage rates, which have been a source of inflationary pressure.
But instead of falling, long-term interest rates went up.
In the immediate aftermath of Liberation Day, yields on 10-year Treasuries initially fell as low as 4.01% but then started gradually rising. By April 9, they were over 4.3%, which was higher than pre-Liberation Day levels.
Bessent to the rescue
Based on subsequent reporting, it appears that bond market “yips,” as Trump described it, may have been instrumental in driving a shift in administration policy.
With Navarro missing from Trump’s side for some reason, Treasury Secretary Scott Bessent, along with Commerce Secretary Howard Lutnick, got to the President and urged him to pursue a strategic pause on his tariff plans.
What followed was arguably the most important social media post in economic history. We recall (with a great sense of relief) the moment the Truth Social alert appeared on our phones just before 1:30pm EST on Wednesday, April 9.
