Tariffs: the most beautiful word in the English language according to President Trump, aims to rebalance US trade and bring manufacturing back to the US. One consequence of this is upending the global system as we know it, and perhaps the end of globalisation.
The knock-on effects of such rhetoric and potential action extend well beyond US borders. For UK gilt markets, the prospect of a more protectionist US, particularly if it triggers retaliatory measures from other major economies, which it already has from China, poses several key risks and channels of influence.
At the forefront is the impact on inflation and interest rate expectations. A significant imposition of tariffs by the US would likely increase import costs, fuelling inflation domestically but also potentially contributing to global price pressures. For the UK, where inflation has only recently shown signs of moderating, a fresh global inflationary impulse could complicate the Bank of England’s path towards monetary easing. In such a scenario, expectations for rate cuts may be pared back, exerting upward pressure on shorter-dated gilt yields.
Simultaneously, increased geopolitical and trade uncertainty typically drives risk aversion. In times of heightened global turmoil, UK gilts often benefit from a flight-to-safety dynamic, and this is indeed what we have seen over the past few days. In concert with higher inflation expectations, this could prompt a decline in shorter term gilt yields and an increase in longer term gilt yields. The resulting steepening of the yield curve would reflect the market’s dual concerns: sticky inflation in the near term and potential economic drag further out. (Reader caution, markets are moving very quickly and curve shape and movements may change!)
Moreover, sterling’s response to a more protectionist US could influence yields indirectly. A weaker pound, either from broader risk-off sentiment or a relatively hawkish Federal Reserve stance, could import inflation, again shaping gilt pricing through the currency channel.
The global response to last week's tariff imposition has so far been cautious rather than overtly retaliatory, though signs of strategic alignment are beginning to emerge. Key trading partners, notably the European Union, have started to formulate their responses. Moving quickly in direct retaliation to the U.S. 'Liberation Day' tariffs, China announced a 34% tariff on imports from the United States. This move underscores Beijing's stance against what it perceives as economic coercion. The EU has also taken steps to counteract the U.S. tariffs, the bloc is preparing countermeasures targeting U.S. goods.
The UK stance towards tariffs remains muted. To inform its potential countermeasures, the UK government initiated a four-week consultation on 3 April 2025, seeking input from businesses on products that could be included in any retaliatory tariff actions. This consultation is set to conclude on 1 May 2025.
Another key impact of the President’s raft of liberation day tariffs has been a sharp rise in Credit Default Swap (CDS) spreads. These financial instruments are contracts that can protect an investor against the default of a counterparty; their spreads therefore provide an insight into the level of credit risk perceived by markets. Since the latest round of tariffs were announced CDS spreads on UK banks have spiked, with some names seeing increases of around 15%.
This has not been limited to the UK; banks across Europe, Australia, and Asia have all seen CDS spreads increase. Canadian banks being one of the worst affected. These increases are due to the uncertainty surrounding the hit to economic growth as a result of tariffs and whether a potential worldwide economic slowdown leads to increases instances of default which would weigh on banks’ creditworthiness. Uncertainty around the extent of retaliatory tariffs is also affecting market sentiment.
The imposition of tariffs and the broader shift toward protectionist trade policy have also begun to influence the term structure of interest rates, with notable implications for both term premia and uncertainty premia. Term premia, the extra yield investors demand for holding longer-dated gilts instead of rolling over short-term securities, can rise in response to elevated inflation risk or fiscal concerns. With tariffs threatening to raise input costs and global supply chain frictions, investors may begin to price in a higher inflation risk over the medium term, nudging up term premia on UK government bonds. Simultaneously, heightened geopolitical uncertainty and the potential for retaliatory trade measures, can elevate uncertainty premia. This reflects compensation investors demand for holding assets exposed to unpredictable policy environments. While a traditional risk-off environment might compress gilt yields, especially at the long end, these premia can counterbalance downward pressure, particularly if investors reassess the macroeconomic and fiscal outlook under a more fragmented global trading regime.
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