Donald Trump’s tariff reversal eases bond market turmoil but economic risks linger for Australia

Donald Trump’s dramatic tariff backflip has soothed turbulent bond markets, but not all is “beautiful”, as the US president declared.

Amid soaring uncertainty, traders remain on edge - with the volatility index at a five-year high - and Australia is not immune to financial shocks from the US.

While Mr Trump was prepared to ride out falls on equity markets, he couldn’t afford to look through what was happening in the fixed income market, as bond yields surged when they should have been going lower, IG markets analyst Tony Sycamore said.

As the risk of an economic downturn rose and hedge funds got squeezed, investors bailed from US government debt, sending bond yields skyward - something Mr Trump couldn’t ignore.

“The bond market is hugely, hugely important. It governs all the other markets,” Mr Sycamore told AAP.

“He realised that he risked causing some very significant damage to the US economy, to the plumbing, to the liquidity, and I believe that was the catalyst for him to change tack.”

Mr Trump acknowledged the concerns after his decision to pause tariffs.

“The bond market right now is beautiful,” he said.

“I saw last night where people were getting a little queasy.”

Brown Brothers Harriman strategists Win Thin and Elias Haddad said the relief rally was likely to be short-lived.

“The pervasive uncertainty created by continuously changing US tariff threats and escalating US-China trade war remains a major drag to the global economy,” they said.

There is a heightened risk that the US falls into stagflation, which spells bad news for bond prices as it would limit the Federal Reserve’s ability to cut rates to boost the economy.

Markets are set for months of uncertainty, with the delayed tariffs still looming overhead.

That could spell trouble for the Australian economy if US bond traders get spooked again.

“We don’t operate in a vacuum and our bond markets are linked to what’s going on in the US,” Mr Sycamore said.

“If yields are going higher in the US, then our bond yields are going higher too.”

That’s especially troublesome for Australia’s banking sector, which derives significant funding from overseas markets.

“When these bond yields start to move around, it makes their funding more expensive,” Mr Sycamore said.

“It’s not something which a one or two-day move is going to be particularly important for.

“But if it happened over the space of a week or two or three or four, and their funding costs start to blow out, that could be problematic for the banks.”

Reserve Bank governor Michele Bullock looked to reassure Australians at a speech on Thursday night.

“The Australian financial system is strong and well placed to absorb shocks from abroad,” she told the Chief Executive Women annual dinner in Melbourne.

Traders are predicting the central bank to cut interest rates at its next meeting in May before possibly delivering another 100 basis points of relief before Christmas.

Each 25 basis point cut would shave about $90 off the monthly interest payments of an average $600,000 mortgage.