Donald Trump wants to put his tax cut plans into action with a comprehensive package of legislation currently being debated in the US Congress. President Trump’s advisors are talking about a “big, beautiful tax bill.” Critics believe that current US policy (taxes, trade, universities, etc.) is much more of a plan to achieve a (poor) BBB rating for the US. The new US administration’s policies have at least increased uncertainty about future developments in economic growth, inflation, monetary, trade, budget, and immigration policy.

An important risk lies in falling international demand for US assets, especially US government bonds. The latter have so far been regarded as the world’s most important safe haven because they “promise” price rises in times of crisis, or more precisely: a negative correlation with risky assets. In addition, US government bonds are used to price many other assets (valuation of equities, corporate bonds with credit risk and emerging market bonds with credit risk). Structural losses in the price of US government bonds would bring unrest to the financial system. The thought experiments that the market is currently conducting on the subject alone harbor the risk of a self-fulfilling prophecy: falling demand for US government bonds could lead to further yield increases. CIO Gerold Permoser has already discussed the future role of US government bonds and the dollar itself in a blog post.

US yields have been rising for months

Yields on US government bonds have been on an upward trend since the most recent low in September 2024. The benchmark yield for the 30-year yield has risen from around 3.9% to around 4.9%. At the same time, the difference between the long-dated (30-year) yields and the short-dated (2-year) yields has increased (from around 0.4 to one percentage point): This is referred to as a steepening of the yield curve.

In theory, this could be attributed to higher expectations for future key interest rates or to a rising risk premium demanded by the market for holding long-term bonds. If we look for clues as to the reasons behind the steeper curve, several factors emerge – not all of which have anything to do with the decline in confidence in US government bonds:

1. Improved growth prospects

Last September, fears of a recession rose in response to poor labor market data. This was followed by surprisingly strong growth indicators. However, “Liberation Day” (April 2), when extensive retaliatory tariffs were announced, caused recession fears to rise again. In response to the suspension of high tariffs for 90 days shortly thereafter, growth fears have subsided once again. The reduction in tariffs on Chinese imports was particularly positive. In fact, some indicators of business sentiment rose in May after slumping in April. In the base scenario, the average US tariff rate is expected to rise from 3% at the end of 2024 to 15%, which will push US growth to a low level in the second half of the year.

2. Higher inflation risks

In general, tariff increases have the same effect as higher taxes. Prices rise, in this case import prices. Some of this will be passed on to consumers in the form of higher prices. This is indicated by rising sales prices in the US Purchasing Managers’ Index for May. In many countries, including the US, goods price inflation is currently at zero percent, while service inflation is just under 4% year-on-year. Assuming that tariff increases will lead to rising goods prices and service price inflation remains high, inflation will rise in the coming months. However, the extent of this rise will depend largely on the actual form of the tariff policy.

3. No interest rate cuts in sight

The first two points argue against interest rate cuts by the US Federal Reserve. Last September, a key interest rate of around 2.8% was priced in for December 2025. Currently, a key interest rate of 3.9% is priced in. The US Federal Reserve is signaling that it will adopt a wait-and-see approach and closely monitor the economic data released. As long as the combination of better growth prospects (no recession) and increased inflation risks remains in place, the arguments for key interest rate cuts are few and far between. Market expectations of key interest rate cuts could therefore continue to be disappointed.

4. Yield increases on Japanese government bonds

The benchmark yield on 30-year Japanese government bonds has risen from around 2% to around 3% since last September. The main reason for the rise in yields in Japan is the return of inflation. In April, consumer prices rose by 3.6% year-on-year. As a result, domestic yields are becoming increasingly attractive for Japanese capital pools (e.g., insurance companies). This is especially true given that confidence in US bonds is waning and the US dollar could weaken against the yen in the long term. Risk: Japanese demand for US bonds could decline, leading to further increases in US yields, even if Japanese yields do not rise further.

5. Uncertainty surrounding US trade policy has increased

The US Court of International Trade (USCIT) ruled that the tariffs imposed by the US were illegal. The scope of the International Emergency Economic Powers Act (IEEPA) had been exceeded. Almost all tariffs imposed on April 2 fall under the court ruling: the 10% base tariffs for all countries, the country-specific “reciprocal” retaliatory tariffs, and the tariffs justified by the fentanyl trade from Canada, China, and Mexico. Not affected are sector-specific tariffs (aluminum, cars and auto parts, steel) and tariffs imposed on Chinese imports during Trump’s first term. In fact, President Trump said last weekend that he would double tariffs on steel and aluminum imports from 25% to 50%.

The Federal Appeals Court has granted the US government a stay of enforcement of the order until further notice. The government plans to appeal the Trade Court’s decision to the Supreme Court. If the Trade Court’s ruling is upheld, the US government will use other legal grounds to impose a base tariff of 10% and higher counter-tariffs, according to Peter Navarro, the architect of US tariff policy. Overall, the legal uncertainty further reduces the already damaged predictability.

6. New taxes

A provision in Trump’s tax budget proposal allows the government to increase taxes on foreign investments from countries whose tax policies disadvantage the US. This would give the US a new lever. If the law is actually passed, the US could tax holders of US government bonds. For example, Japan has long been the US’s largest foreign creditor and currently holds US$1.13 trillion in US government bonds (source: US Department of the Treasury). This represents a new incentive to reduce US government bond holdings.

7. Financial repression

In addition, working papers also discussed other repressive measures such as converting government bonds into long-term (100-year) bonds or even perpetual bonds. This would probably amount to de facto bankruptcy.

8. Science

The Trump administration wants to stop foreign students from enrolling at Harvard University. This measure could undermine competitiveness and put pressure on the US dollar.

9. The rising budget deficit

Almost at the end, the classic argument: the budget deficit is very high and the dynamics of government debt point to a rapid increase in the government debt ratio. In March of this year, the Congressional Budget Office (CBO) predicted that the federal government’s publicly held debt could rise from 100% of gross domestic product (GDP) in 2025 to 156% in 2055. The draft budget currently before the US Congress suggests that the tax cuts could be greater than the spending cuts.

10. Pressure on the central bank

It is therefore becoming apparent that fiscal policy will remain loose to neutral and will not become restrictive, as was expected for this year last year. That alone would require a restrictive interest rate policy (i.e., slightly higher key interest rates) if a cautious approach were taken. If the central bank nevertheless lowers key interest rates even though no recession is in sight, the long-term inflation risk premium could rise. That would mean higher yields.

US President Trump has repeatedly expressed his opinion on the “right” interest rate policy. This was also the case last week: at their first meeting in Trump’s second term, President Trump told the head of the US Federal Reserve, Jerome Powell, that he was making a mistake by not loosening US monetary policy. Lowering key interest rates to offset a perceived competitive disadvantage vis-à-vis other countries or to reduce the government’s interest payments is not one of the classic objectives of a central bank. In the US, the objectives are price stability and full employment. If key interest rates are lowered even though the unemployment rate is low and inflation is high, inflation could remain above the central bank’s target of 2% in the long term.

 

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