Trade, Tariffs, and Treasuries: The Hidden Cost of Trump’s Protectionism

The Trump administration’s trade policy—specifically its broad, aggressive use of tariffs—has several direct economic costs and benefits: higher inflation, an effective tax on consumers and businesses, and increased government revenue. Trade policy also has a number of indirect implications, including on the U.S. Treasury market. Treasuries are critically important for the United States, from economic, financial market, and geostrategic lenses, and policymakers need to understand their potential impacts in the next year and beyond. Three avenues are particularly noteworthy: bond supply, bond demand, and the effect of economic growth and inflation trends on the Treasury yield curve. Several trade-related policy ideas could help ensure that the Treasury market remains sound over the longer term. 

Funding the Government and Treasury Supply 

The U.S. budget deficit, now around 6 percent of gross domestic product (GDP), is roughly double what the country experienced on average from 1980 until the COVID-19 pandemic. Bigger deficits require that the government issues more bonds. Without similarly increased demand for U.S. Treasuries, the potential mismatch in demand and supply will lift longer-term yields, assuming all else is equal.

That is where tariffs come in. More tariff revenue can marginally help reduce needed bond issuance, which in turn can limit the risk that yields rise.

Tariff rates have surged to around 16 percent, the highest level since 1935, leading to a sharp increase in tariff-generated revenue this year. The federal government collected $195 billion in customs duties in fiscal year 2025, more than 250 percent of what it collected in the prior fiscal year, an increase to which tariffs contributed. (Even accounting for this revenue, the budget deficit for FY 2025 reached $1.8 trillion).  

If held at current levels, the Congressional Budget Office (CBO) estimates that tariffs would reduce U.S. budget deficits by roughly $3 trillion through 2035 (although this does not account for changes in the size of the U.S. economy.) 

Those assumptions are risky. The Supreme Court could strike down some or all of the International Economic Emergency Powers Act (IEEPA) tariffs, and the One Big Beautiful Bill (OBBB) could cause long-term increases to the deficit. If the former were to occur, an analysis by the Yale Budget Lab estimates tariff revenue would be cut by about half.

The Trump administration has suggested in that case, it could use other trade laws to effectively replace some portion of that lost revenue. The OBBB is also expected to add $3.4 trillion to the deficit over the next decade, as estimated by the CBO, potentially erasing fiscal gains from tariff revenue. The timing and evolution of policy in those contingencies suggest volatility for Treasury bonds as investors have to recalibrate their expectations for bond issuance.  

There are also questions on future administrations. Beyond changes to fiscal policy, would they also change trade policy? Could tariffs revert to the Joe Biden era, with a greater focus on strategic industries and China, reducing overall tariff revenue? Or will future administrations calculate that, over time, the need for revenue and the challenge of finding it means broader tariffs are best left in place?

Although the longer-term tariff rate is unclear, trade policy shifts should influence expectations for the amount of bonds needed to fund budget deficits. All else being equal, more bond supply with demand held constant will result in higher longer-term bond yields.

Treasury Secretary Scott Bessent is clearly aware of those risks, and has highlighted supply-related bond volatility in the third quarter of 2023 as a cautionary tale. After the Treasury Department announced in summer 2023 that it would need to issue more debt than had been expected in the third quarter, the U.S. government’s credit rating was downgraded by Fitch Ratings. Perhaps not surprisingly, the 10-year Treasury term premium rose sharply. Bond yields quickly climbed toward 5 percent and equities fell by 3.3 percent during the quarter.

Indeed, Bessent and his team have taken a number of steps this past year to ensure sufficient demand for Treasuries to meet supply, reducing the risk of higher long-term yields that act as the anchor for U.S. mortgages and auto loans, which in turn can influence consumer sentiment on the economy and the White House.

One such effort by the Treasury focuses on the maturity of new debt issuance. In November, the department guided market participants to expect relatively more issuance on the front end to the intermediate sector of the bond yield curve for the “next several quarters.” Though this can help longer-term borrowers, it comes with risks, mainly refinancing risk should T-bill yields suddenly rise and create broader market volatility.

The former could be triggered by a number of catalysts, including a political standoff over the debt ceiling or a government shutdown, greater risk of another credit rating downgrade, or large volumes of maturing short-term debt. Many market participants expect that the Treasury will need to increase the issuance of longer-term bonds starting in the fourth quarter of 2026, partly to ensure market liquidity along the yield curve.

Tariffs and Treasury Demand 

Forecasting Treasury demand is as difficult to confidently forecast as tariff revenue and subsequent Treasury supply. Some Treasury buyers, including the Federal Reserve, U.S. banks, and foreign public-sector entities, are relatively less price sensitive and more longer-term focused. They tend to provide a reliable source of demand.

Unfortunately, the government cannot rely on those buyers as much as in the past. According to J.P. Morgan analysis of Federal Reserve data, a combination of the Fed (through quantitative easing), U.S. banks, and foreign investors now account for about half of the Treasury market, down from an average 66 percent in the twenty years up to the pandemic.

Demand will be supported, at least marginally, into 2026 as the Federal Reserve ends its quantitative tightening program (in which it reduced the amount of bonds it held on its balance sheet). Indeed, it will become a net buyer of bonds in 2026 (mainly T-bills), in part to ensure ample reserves. Bank demand for Treasuries, meanwhile, will partly reflect deposit growth and could potentially increase in the wake of easier regulations (i.e., reform to bank supplemental-leverage ratios.)

The source of bond demand most clearly tied to trade, meanwhile, comes from overseas. As seen in figure 2, foreign investors hold just above 30 percent of the Treasury market. Worries increased around a reduction in this demand immediately after April's Liberation Day tariffs were announced and U.S. bonds, equities, and the dollar all sold off.

However, data in subsequent months has not provided evidence that foreign investors are notably changing bond allocations. Treasury data shows that through September 2025, foreign net purchases of Treasuries reached $472 billion, which is on track to be slightly higher than 2024. Historical precedent backs this up as well—during the initial trade war in the first Trump administration, foreign holdings of Treasuries increased from $5.95 trillion at the beginning of 2017 to $7.12 trillion when President Donald Trump left office in 2021.

The reassuring trend in part reflects the Treasury market’s dominant global position. At roughly $29 trillion, its size is multiples greater than other large, developed economies’ bond markets. That means that U.S. Treasury bonds offer relatively better liquidity and lower transaction costs.

Still, the recent state of demand does not guarantee steady buying going forward, especially in the case of foreign investors. First, about 30 percent of foreign owners of Treasury bonds are central banks and sovereign wealth funds. Although they have not reduced U.S. bond holdings so far this year, many reserve managers suggest they will in the years ahead. A 2025 Official Monetary and Financial Institutions Forum survey of seventy-five central banks found that respondents plan gradual diversification away from the dollar in coming years, including further toward gold. Second, the duration of Treasuries owned by foreign investors has gotten shorter over the years. If those investors want to lighten their U.S. dollar-denominated exposure through bonds in a passive way that does not attract public attention, they can simply let holdings mature and replace fewer of them going forward.

Historically, the currency composition of central bank reserves has been influenced by trade relationships. Large central bank holdings of dollar-denominated assets today reflect the role the United States plays as a trade partner of choice, in turn driven by a large, strong consumer base and generally robust economic growth.

If the United States’ more protectionist trade policy leads other countries to diversify trade toward other partners, related reserve shifts could follow. Such a scenario could marginally reduce foreign demand for Treasuries.

The Treasury Department, in part to limit such risks, appears to be seeking other demand sources, among them U.S. dollar stablecoins. To ensure a stable value in dollars, stablecoins require full backing by high-quality reserves such as cash, short-term Treasuries, and other high-quality liquid assets. Their increased adoption could drive a new source of Treasury buying, although largely in short-term T-bills. (Other sources of sustained demand highlighted by the Treasury and other investors include pensions and households.)

The prevalence of stablecoins creates unique risks for the Treasury market. Indeed, while issuers are required to maintain 1:1 reserves of liquid instruments, their holdings are not completely risk-free. As figure 3 shows, Circle and Tether (the two largest issuers of stablecoins) hold significant amounts of money-market instruments such as overnight reverse repurchase agreements, which are subject to liquidity and settlement risk. A bank run on issuers could push short-term yields higher as they start to liquidate holdings. Tether’s Bitcoin and precious metal holdings are also subject to market volatility that could put stablecoin’s dollar peg into question in moments of stress.

Putting Treasury supply and demand together, the current overall picture for 2026 suggests only muted risks of significantly higher yields. In the longer term, however, questionable foreign and stablecoin demand, and the need to increase issuance to fund budget deficits, suggest that risks of higher long-term yields will remain.  

Fed Policy, Growth, and Inflation 

Two other trade-related factors could meaningfully influence Treasury yields: expected and actual growth and inflation trends. Both influence the Federal Reserve’s decisions around the Fed funds rate, which in turn anchors the yield curve.

In the days after the Liberation Day tariff announcements, expectations for growth softened but inflation rose. That led to a steeper yield curve, with the 10-year Treasury yield rising 34 basis points in just 7 days. Higher tariffs in the future raise the risk of stickier goods inflation and potentially retaliatory trade hits to growth, as well as larger deficits due to spending and tariff-driven revenue shortfalls, thereby pushing up both inflation and term premium. (Term premium refers to the additional return, or yield, required by investors to hold bonds with longer maturities relative to a series of shorter-term bonds.)

Beyond trade shocks, other factors influence Fed decisions and the related growth and inflation sentiment that flows through the yield curve. Productivity boosted by artificial intelligence, for instance, could lift yields through expected stronger growth, while an exodus of foreign workers could lower yields if it were seen as likely to slow growth, as the Dallas Federal Reserve concluded in a July research report.  

Still, expectations for tariffs to indirectly influence U.S. monetary policy can be meaningful. On November 12, Atlanta Fed President Raphael Bostic said he viewed inflation as the larger risk to the Fed’s dual mandate, and presented survey evidence that American firms saw 40 percent of their total unit cost growth in 2025 and 2026 coming from tariffs. Similarly, Fed Vice Chair Philip Jefferson said in a November 17 speech that “lack of progress” on the central bank’s inflation target “appears to be due to tariff effects.” 

While the Fed is expected to cut interest rates in 2026, worries around sticky inflation could result in less Fed accommodation than expected. Such an outcome would likely support longer-term bond yields, all else being equal.

Why Longer-term Treasury Yields Are so Important  

The 10-year U.S. Treasury yield’s importance can be understood through three avenues. First, it is critical for household and business borrowing, including individuals looking to get a home mortgage or auto loan. It influences how much companies pay to grow their businesses. Second, higher bond yields effect U.S. fiscal dynamics in a number of ways. As interest payments on debt increase and use a greater share of available government funds, policymakers become more constrained around other fiscal priorities. They also can be more challenged when they need to respond to economic shocks.

Finally, because U.S. Treasuries and the dollar are globally dominant, they influence market and economic trends around the world. Yields influence the dollar’s value against other currencies. Changes in foreign currencies, usually a mirror image of the dollar, in turn influence local growth and inflation conditions that can flow through to monetary policy and asset prices.

What happens to U.S. trade policy, both in the coming months and years, will continue to shape the Treasury market, which in turn will influence macro trends globally. With that in mind, and given the importance of protecting the benefits that come to the United States from a healthy and attractive government bond market, U.S. policymakers should consider the following:

• Continue to review, refine, and, where possible, reduce tariffs. Policymakers should consider reductions in tariffs for products and industries (1) not deemed as strategically important (such as semiconductors and pharmaceutical ingredients); (2) not easily produced in the United States (such as certain tropical foodstuffs like bananas and coffee); and (3) where they have an outsized effect on consumer price inflation and, in turn, U.S. monetary policy. This step would be an extension of actions recently taken by Trump administration with select food and agricultural imports. Although removing some tariffs will require increasing needed Treasury issuance at the margin, that risk would be in part offset by the benefits derived from improving expectations around growth and prices.
• Prioritize research on dollar stablecoins to understand the risks posed to the Treasury market. Research should lead to further regulatory digital-asset guardrails if deemed necessary to support a stable, reliable Treasury market.
• Ensure that the Federal Reserve remains independent, in name and action, to control inflation and inflation expectations. That independence will influence Treasury bond-term premiums. This could directly help lower bond yields but also reassure core buyers of government bonds, which will be critical to absorb increasing bond supply in coming years.
• Create a bipartisan congressional group to research long-term U.S. fiscal sustainability and propose legislation. That research should include entitlements such as Social Security, particularly given the increasing risks that it could be depleted in the coming decade. Although deficit reduction should be the ultimate goal, term premiums embedded in Treasury bond yields could be reduced even before such a goal is reached simply by showing a credible, bipartisan effort to take fiscal dynamics seriously. Many steps that could achieve deficit reduction are politically unpopular. With that in mind, it is essential to implement a bipartisan, government-led educational campaign to help the American public better understand the risks faced if the current fiscal trajectory is not addressed. 

Conclusion

The Trump administration’s trade strategy has created a fiscal cushion but has also introduced significant uncertainty to the U.S. Treasury market. Though elevated tariff revenues could reduce needed bond issuance and ease upward pressure on yields, they are far from a cure-all given structural deficits, legal challenges to tariff authority, and new spending commitments like the OBBB. Those dynamics, coupled with evolving demand patterns from foreign investors and emerging sources such as stablecoins, suggest bouts of Treasury volatility are likely.

Looking ahead, preserving the Treasury market’s stability in the long run will require a balanced approach: refining tariffs to limit stagflationary spillovers, strengthening regulatory oversight of new demand sources, and taking steps toward fiscal sustainability. Without such measures, the interplay between trade and Treasury dynamics could amplify volatility and raise long-term yields, with consequences that extend well beyond the U.S.’ borders.

The author(s) thank the participants of the Trade and Markets Working Group for their insights and feedback. The analysis and conclusions are the responsibility of the authors.