US Treasuries' Defiant Run Amid Trump Tariff Turmoil

The recent defiant run of US Treasuries amidst the economic uncertainty caused by President Donald Trump's tariff policies has left investors puzzled. As the world grapples with the potential fallout from Trump's trade wars, US Treasuries have emerged as a surprising safe haven, defying the conventional wisdom that such assets would suffer in times of economic turmoil. This phenomenon raises several questions: Are hedge funds selling off equities to buy Treasuries, or is China dumping its holdings to protect its economy? The answer lies in a complex interplay of geopolitical tensions, interest rate expectations, and recession concerns.



The primary factor driving the recent defiant run of US Treasuries is their safe-haven status. In times of economic uncertainty, investors flock to assets perceived as stable and secure. The announcement of sweeping tariffs by President Trump has created significant market volatility and concerns about a potential global recession. As a result, investors are seeking the relative safety of US Treasuries, which are less sensitive to interest rate fluctuations compared to other assets. For instance, the MSCI World Index tumbled 9.3% on Thursday and Friday, the biggest two-day decline since March 2020, indicating a strong flight to safety.

Interest rate expectations also play a significant role in this phenomenon. The Federal Reserve's communications and recent inflation data have raised the possibility that interest rates could remain higher for longer than initially expected. This uncertainty has led to a recalibration of expectations for monetary policy, creating a challenging environment for highly-leveraged positions. As a result, investors are seeking the stability of US Treasuries, which are less sensitive to interest rate fluctuations compared to other assets.

Geopolitical tensions across multiple fronts, from Eastern Europe to the Middle East and Asia, threaten global supply chains, energy markets, and business confidence. These tensions have prompted hedge funds to reduce risk exposure until greater clarity emerges, further driving demand for US Treasuries. For example, hedge funds have liquidated global equity positions at the fastest rate on record, indicating a significant shift in market sentiment towards safer assets.

Recession concerns remain despite resilient economic data. Many hedge funds may be positioning themselves defensively in anticipation of an economic slowdown, particularly as the lagged effects of tight monetary policy work their way through the financial system. The Yale Budget Lab estimates that Trump’s 2025 tariffs will increase U.S. consumer prices by 2.3% in the short run, costing American households $3,800 a year, which adds to the economic uncertainty and drives investors towards safer assets.

Increased volatility is the most immediate consequence of hedge fund liquidations of this magnitude. As these large institutional players unwind positions, price swings tend to become more pronounced across affected markets, creating both challenges and opportunities for traders. This volatility has led to a greater demand for the stability of US Treasuries, as investors seek to mitigate risk.

Hedge funds are responding to the tariff turmoil by significantly reducing their stock exposure, as indicated by the most recent Prime Book data on global equities. This sell-off has generated the lowest rolling 2-week notional net flow Z-score since records began, indicating an extraordinary level of liquidation that exceeds previous records. This coordinated response suggests a shift in market sentiment and outlook, driven by multiple significant catalysts.

One of the primary drivers of this exodus from equities is rising interest rate concerns. Markets had anticipated rate cuts in 2024, but recent inflation data and Federal Reserve communications have raised the possibility that rates could remain higher for longer than initially expected. Persistent inflation readings above the Fed's 2% target have contributed to this uncertainty, creating a challenging environment for highly-leveraged hedge fund positions.

Geopolitical tensions also play a significant role in this response. Conflicts across multiple fronts, from Eastern Europe to the Middle East and Asia, threaten global supply chains, energy markets, and business confidence. These tensions prompt hedge funds to reduce risk exposure until greater clarity emerges.

Additionally, recession concerns remain despite resilient economic data. Many hedge funds may be positioning themselves defensively in anticipation of an economic slowdown, particularly as the lagged effects of tight monetary policy work their way through the financial system.

To mitigate potential risks, hedge funds are employing several strategies. They are adding bets against stocks and ditching long positions, as seen in the largest single day of selling in global equities that Goldman Sachs’s prime brokers had seen. This selling was dominated by short positions, with the US contributing to 75% of the selling. Asia fundamental long-short managers were down 2.4% over the two days, trimming this year’s gain to 2.8%. Japan led the selling in the region, contributing 70% for the week.

Hedge funds are also seeking safety ahead of the tariff announcement, as seen in the unwinding of positions and the reduction of net leverage. Morgan Stanley estimates that U.S. long-short funds net leverage quickly fell to 37%, "just shy of historical lows," by the end of Friday, from over 50% at the beginning of the year. This conservative positioning reflects the significant volatility expected in risk assets due to tariff uncertainties.

In summary, the recent defiant run of US Treasuries is driven by their safe-haven status, interest rate expectations, geopolitical tensions, recession concerns, and market volatility, all of which are exacerbated by Trump's tariff policies. Hedge funds are responding to the tariff turmoil by liquidating global equity positions at an unprecedented rate, driven by rising interest rate concerns, geopolitical tensions, and recession fears. They are mitigating potential risks by adding short positions, ditching long positions, and reducing net leverage to conservative levels.