Bond Market Sentiment Shifts as Recession Risk Rises

The bond market has undergone a significant shift in sentiment, with yields falling and recession risk increasing due to President Trump's policies. The benchmark 10-year yield dropped three basis points to 4.27% on Monday, despite Trump's assurances that the economy is facing only "a period of transition."

Key Drivers of Market Sentiment

Several factors have contributed to the shift in market sentiment:

1. Trade War: Trump's brewing trade war with China and other countries is likely to deliver another inflation shock and roil global supply chains.
2. Tariffs: The administration's efforts to impose tariffs on Mexico and Canada have added to market concerns about the potential impact on economic growth.
3. Federal Funding Cuts: The administration's plans to withhold federal funding and fire tens of thousands of government workers have also taken a toll on market sentiment.

Bond Traders Prepare for Recession

While bond traders have prepared for the economy to falter repeatedly over the past few years, only to be burned when it continued to power ahead, this time they seem more convinced that recession risk is higher. "Recession risk is definitely higher because of the sequence of Trump's policies – tariffs first, tax cuts later," said Tracy Chen, a portfolio manager at Brandywine Global Investment Management.

Fed's Role in Easing Monetary Policy

The Federal Reserve has announced three quarter-point rate cuts this year, but bond traders remain skeptical that the Fed will be in recession-fighting mode. On Friday, Fed Chair Jerome Powell said he is not in a rush to resume easing policy, citing "elevated levels of uncertainty."

Inflation and Economic Data

However, signs that the economy is cooling have been steadily piling up, including the Atlanta Fed's GDPNow gauge, which is signaling the US gross domestic product is set to shrink in the first quarter. Inflation may also keep upward pressure on yields, with the consumer price index report this week expected to show a yearly increase of 2.9% in February.

What to Watch

Economic data releases over the next few weeks will be closely watched for signs of economic slowdown or acceleration:

1. NY Fed 1-Year Inflation Expectations: March 10
2. NFIB Small Business Optimism: March 11
3. MBA Mortgage Applications: March 12
4. Consumer Price Index: March 12
5. Producer Price Index: March 13

Fed Calendar and Auction Schedule

The Federal Reserve will observe a communications blackout ahead of its policy meeting on March 18/19, while the auction calendar includes several key bond sales over the next few weeks.

Conclusion

The bond market's shift in sentiment reflects growing concerns about recession risk and the potential impact of Trump's policies on economic growth. While the Fed has announced rate cuts to ease monetary policy, bond traders remain skeptical that this will be enough to prevent a slowdown.