Up until this year, tariffs haven’t been a major investment consideration for most investors who are currently active in the market. Tariffs were big news in the administrations of Herbert Hoover (1929-1933) and, to some extent, Richard Nixon (1969-1974). Since then, not so much.
It’s understandable, then, that bond buyers were generally unfamiliar with the intricacies of trade protection prior to April 2, 2025. That was “Liberation Day,”when President Donald Trump announced new tax rates on exports of U.S. adversaries and allies alike. Over the next few days, fixed income investors learned the new Three Rs of tariffs—Retaliation, Repercussions, and Reprieve. ¹
On April 2 the yield on the benchmark 10-year Treasury bond stood at 4.18%.² Trump set out to retaliate against foreign governments’ unfair trade practices by imposing a 10% baseline tariff plus additional levies set by formula, country by country. The 10-year Treasury yield’s initial response was to drop to a low of 4.01% on April 4.
Two more Rs helped to explain that move—Recession Risk. Investors worried that protectionism would trigger a contraction in global trade, with all countries’ economies suffering as a result. In that scenario, companies cut back on investment plans in expectation of reduced demand for their products. Demand for debt capital consequently declines, causing bond yields to fall. That’s good news for existing bondholders because, as the daily newspapers frequently remind us, bond prices rise when their yields decline.
Unfortunately, the gains on bonds didn’t last very long. The 10-year Treasury yield reversed course, soaring to a peak of 4.47% on April 11. A 46-basis-point (1 basis point = 1/100 percentage point) change represents an exceptionally large move in the course of just five trading sessions. It exceeds 99.8% of the five-session moves up or down of the past 20 years.
Technical factors might explain the 10-year Treasury yield’s extraordinary rise from April 4 to April 11. One contributor could have been unwinding of leveraged basis trades, which seek to profit from disparities between futures and spot prices of commodities. Also, in reaction to America’s heightened tariffs, other countries were seen as scaling down their participation in U.S. Treasury auctions or even reducing their existing holdings. On a more fundamental level, investors may have been starting to focus on tariffs’ potential to stoke inflation. Accelerating inflation is associated with rising interest rates.
Such analysis lent insight into what had already happened, but on Monday, April 14 the 10-year Treasury yield reversed course yet again, dropping to 4.37% from 4.47% on the preceding Friday. The latest change of direction followed a modification of the administration’s aggressive stance on tariffs. Trump and his advisors may have been influenced by financial markets’ violent reaction to the initial position statement. Another likely factor was pushback on tariffs from prominent business leaders who had generally supported Trump, based on his tax and regulatory policies.
Bond Strategy for the Present
Up to this point I have focused on Treasury bonds, which are pure indicators of interest rate movements. Many income-seeking individuals, however, look more to opportunities in corporate bonds. Those securities offer a yield premium over comparable-maturity Treasuries, based on credit risk and lesser liquidity than Treasuries, which trade in the world’s deepest market.
The remainder of the discussion deals with the largest component of the investment grade corporate market—Triple-Bs, i.e., bonds rated Baa by Moody’s Investors Service and BBB by Standard & Poor’s. Most bonds of this quality are deemed suitable for investors with medium-risk profiles, according to the recommendations published in Income Securities Investor. The newsletter even judges some Triple-Bs suitable for low-risk investors, but it’s best to check the ISI newsletter or website regarding any specific bond’s suitability.
Triple-Bs’ yield premium, or spread-versus-Treasuries, increased sharply from 119 basis points on April 2 to 149 basis points on April 9. The above mentioned escalation in recession risk meant that corporate bonds now faced somewhat higher risk of rating downgrade. A drop in a Triple-B bond’s ratings to the next tier down, Double-B, reduces its liquidity and puts it a step closer to the “ultimate downgrade,” namely, default. To compensate for the increased danger of those sorts of outcomes, the bond market demands higher spreads-versus-Treasuries on corporate bonds as the probability of recession rises.
Several unresolved questions about tariffs and their consequences create near-term price risk for corporate bondholders. Underlying Treasury yields could rise if investors become convinced that tariffs will fuel higher inflation than the market currently expects. In the worst of all worlds, the U.S. could become mired in stagflation, a combination of higher inflation and stagnant economic performance that keeps downgrading risk at a high level.
Fortunately, a path exists for investors who want to capture an attractive yield while preserving principal over the long run. It’s also a way to avoid being locked into yields that may turn out to be substantially below market within a few years. The strategy that addresses these objectives is to create a corporate bond ladder.
Currently, for example, Triple-B bonds within the ICE BofA US Corporate Index with maturities of five to seven years yield 5.48% on average. These bonds expose you to less price risk from a general rise in interest rates than longer-dated issues.(An even more conservative approach would be to create your ladder out of bonds with maturities of three to five years, at some sacrifice in yield.)
You can divide your laddered portfolio equally into segments of five, six, and seven years. If yields are higher in 2030 than currently, you can reinvest the proceeds of your bonds maturing in that year at the then-prevailing levels. No one can predict which year from 2030 to 2032 might represent a cyclical peak or trough in interest rates. Receiving some cash for reinvestment in each of those years protects you against the misfortune of having to put it all to work at a low point.
One additional attraction of the corporate bond ladder strategy concerns the principal protection objective. When each of your bonds matures, you receive its full face amount ($1,000), no matter how far its price may have fallen in the interim due to downgrading or a general rise in interest rates.
To be sure, that assumes your bond hasn’t defaulted during your five-to-seven-year holding period. But the risk of a bond defaulting while rated Triple-B is minimal. Moody’s reports a 0.26% average one-year default rate on Baa issuers. The highest rate since the Great Depression was 1.01% in the Great Recession year of 2008. Downgrading to Double-B or lower has almost always given investors fair warning that default risk has stepped up. Taking a loss at that point is the conservative route. The risk of such loss can be diversified by dividing your holdings among several different issuers.
Conclusion
All financial market participants are currently operating without many reference points, as tariffs are far from a regularly recurring phenomenon. Bonds have been whipsawed lately by shifting administrations positions on its new trade barriers. Fortunately, a bond laddering strategy offers income-focused investors good prospects for achieving their objectives without taking excessive credit or interest rate risk.
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1 Dartmouth economist Douglas Irwin’s earlier version of the Three Rs addressed the historical purposes of tariffs: Revenue, Restriction, and Reciprocity.
2 All yields referred to in this report are based on effective yield, a measure that takes into account provisions for early redemption (also known as call features)
