How Tariffs Impact Credit Markets

Additional content provided by Colby Hesson, Analyst, Research.

On Sunday, February 9, President Trump announced new tariffs on steel and aluminum imports. These actions are consistent with his campaign promises to protect American industries and reduce the trade deficit through the use of tariffs. These new tariffs are in addition to the 10% across-the-board tariff on Chinese imports that went into effect on February 4, reinforcing his administration’s tough stance on trade with China. Further, there is the looming threat of 25% tariffs on imports from Mexico and Canada, which have currently been delayed until March 4. This leaves some questions up in the air about if these tariffs will come in the future or if the terms will change.

Tariffs can also cause the credit market to react negatively. Investors become wary of potential economic disruptions, which can lead to wider credit spreads as they demand higher returns for taking on additional risk. Conversely, when tariffs are reversed or postponed, credit markets tend to react positively as perceived risk diminishes. Interestingly, the effect on Treasury yields is often the opposite to that of credit spreads. When tariffs are introduced, investors flock to the safety of U.S. Treasuries, driving their yields down. Meanwhile, credit spreads widen as the risk premium on corporate bonds increases. This dynamic creates a buffer for the overall effect on credit total returns, as the two effects can partially offset each other.

High-Yield Spreads

Corporate high-yield (HY) credit spreads respond to tariff policy shocks, widening when tariffs are imposed and tightening when they are relaxed. In 2019, for every $10 billion increase in tariff revenue, USD HY index spreads widened by 2–13 basis points (bps). While counteracting movements in Treasury yields can act as a hedge for total returns, tariff risk is one of the most likely potential catalysts for a rebuild in HY credit risk premia in 2025. As tariffs create economic uncertainty, investors should closely monitor HY bond spreads and consider the implications for their long-term investment strategies.

In the short term, high-yield bonds might not be as appealing because the spreads might not be broad enough to justify the additional risk compared to safer investments like U.S. Treasuries. The immediate market volatility and economic uncertainty caused by tariffs can lead to higher default risks, making high-yield bonds less attractive to short-term investors seeking stability.

Seven Tarriff Announcements Under Trump in 2019

Source: Goldman Sachs 02/11/25

The “Seven Tariff Announcements Under Trump in 2019” table demonstrates that when tariff revenue is expected to increase, high-yield spreads rise while 10-year Treasury bond yields decrease, and vice versa. The size of the implied revenue also impacts how spreads will react, with a delay, slightly impacting yields, while an increase or reversal makes a larger move in spreads. It is important to understand the frequency and timeline of past tariffs under the Trump administration.

Conclusion

The LPL Strategic and Tactical Asset Allocation Committee (STAAC) favors core bonds over high-yield credit. Yields for high-yield bonds are hovering around historical averages, with spreads remaining near record lows. Overall, the environment continues to support credit risk. While economic growth is slowing, it's not collapsing, which typically benefits credit. However, credit remains expensive. In our view, valuations for riskier fixed income sectors are still rich compared to core sectors. Despite limited potential for price appreciation, income levels remain attractive as long as inflationary pressures persist.