May 29 - Investors worldwide woke up on Thursday to news that the U.S. Court of International Trade had ruled that U.S. President Donald Trump exceeded his authority with many of the tariffs announced since January. But this news isn’t as good as it may seem at first glance, especially for the U.S. Treasury market.
For now, the Trump administration has been given 10 days to return previously paid tariffs with interest to importing businesses. But in the meantime, the U.S. Federal Court of Appeals can stay the lower court’s order. And no matter what the appeals court decides, it seems likely that the case will make its way to the Supreme Court, which probably would not decide on the case until next June.
A resolution is thus likely at least a year away. Until then, the legal uncertainty adds to the already record-high economic uncertainty being engendered by the Trump administration.
Trump will likely try to find workarounds to impose the tariffs anyway. Section 301 of the 1974 Trade Act appears to give the president the power to impose tariffs against foreign countries and businesses if they engage in "unfair trade practices".
This was the legal authorisation that President Joe Biden used to impose tariffs on Chinese electric vehicles, solar cells and other critical materials. It seems plausible that this act could be used as justification for imposing tariffs based on the “unfair” practices – however ill-defined – that Trump believes created the U.S. trade deficit with other nations. Of course, these attempts would also be challenged in court and would likely make their way to the Supreme Court as well.
If the various decisions ultimately go against the Trump administration, this would not only have serious implications for presidential powers moving forward, but also U.S. Treasuries right now.
The nonpartisan Tax Foundation, opens new tab estimates that the tariffs Trump announced in recent months will bring in up to $1.4 trillion in revenues over the next decade based on conventional assumptions. If the tariffs’ potential negative impacts on GDP growth and inflation are taken into account, the additional revenue would likely be smaller, but it could still amount to more than $920 billion, according to the Tax Foundation.
Meanwhile, the U.S. Congress is currently debating the Trump administration’s budget bill, which includes significant tax cuts. The Tax Foundation estimates, opens new tab that this bill, if enacted, will increase budget deficits by an average of 1.4% of GDP per year over the next decade.
This means the U.S. is projected to run budget deficits in excess of 7% of GDP for the foreseeable future. If the tariff revenues are eliminated, this deficit could increase by another 0.4% of GDP each year. My calculations, which take into account the above projections for budget deficits as well as estimates for nominal GDP growth over the next 10 years, indicate that the debt pile of the U.S. could grow by $4.3 trillion over the next decade and push the U.S. debt/GDP ratio to the same level as Italy’s.
The result would likely be even higher Treasury yields, particularly for long-dated bonds, as investors would reasonably demand a higher term premium, or excess compensation for the risk of holding long-dated bonds versus rolling over short-dated debt.
The clearest sign that the market is already getting anxious about the U.S. fiscal position is the movement in credit default swaps. The cost to insure against a default of the U.S. government in the next five years has risen to 54 basis points in recent months. This is higher than the cost of insuring against a default of Italy and almost as high as the insurance premium for Greece. The U.S. spread is likely being skewed by concerns that the country could experience a technical default if the debt ceiling is not raised, but the trend is worrisome nonetheless.
Of course, the elimination of the tariffs could reduce inflationary fears moving forward, putting downward pressure on Treasury yields.
And without the potential for tariff revenues, the Trump administration could be forced to consider other ways to reduce the country’s deficit, though, fiscal prudence hasn’t exactly been on the top of the agenda for either Republican or Democratic presidents in recent decades.
So if the projected tariff revenues are reduced, the bond vigilantes, which have retreated recently, may come back with a vengeance.
Joachim Klement is an investment strategist at Panmure Liberum, the UK's largest independent investment bank.
Writing by Joachim Klement; Editing by Anna Szymanski and Alison Williams
