Credit Investors Weighing Bonds to Sell In Tariff Response

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(Bloomberg) — Credit investors are facing a choice as the Trump administration turns tariff threats into reality: Sell bonds in exposed companies and avoid further losses or bet that the businesses are strong enough to weather it.

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The knee-jerk reaction has been to sell. More than three-quarters of US dollar bonds issued by emerging market companies dropped on Monday morning, based on data compiled by Bloomberg. In Europe, bonds in carmakers, led by Volkswagen AG’s riskiest slice of debt, were the biggest decliners. And in the US, a gauge of credit risk rose the most intraday since last Monday’s global market rout, reflecting fears that tariffs will reboot inflation.

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The specter of a trade war is adding uncertainty to an already fragile global credit market, which have just steadied from the selloff triggered by the realization that the US Federal Reserve is likely to hold off on cutting rates again for much of this year.

Already on Monday, traders were hit with whiplash as President Donald Trump agreed to delay levies against Mexico for an additional month to negotiate. That happened only hours after markets began to prepare for the US to impose tariffs on Canada, Mexico and China on Tuesday, with Trump also reupping his threat to impose them on the European Union.

Read: Treasuries Traders Warn of Stagflation Risk as US Curve Flattens

“Where this could become bearish is if you can project a strategic rise in inflation that would force the Fed’s hand” and result in rate hikes, said Viktor Hjort, global head of credit and equity derivatives strategy at BNP Paribas. However, if tariffs don’t change anything strategically, credit investors will step back in, he said, adding that today’s moves were “a perfectly natural reaction to uncertainty.”

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After news of the delay, the spread on the Markit CDX North American Investment Grade Index, which drops as perceived credit risk falls, pared its jump slightly. Other markets followed suit — stocks pared losses and the dollar pulled back from its rally.

The market reaction broadly reflects the concerns that tariffs could fuel inflation in the US, making the Federal Reserve more careful about lowering rates. At the same time, higher levies on European exports — if they come — could spur the European Central Bank to cut rates even more aggressively to offset the economic hit. That dynamic has left the euro approaching parity with the US dollar.

In Europe, internationally-exposed carmakers — already a pain point for corporate bond investors in previous months — are a key focus for investors. Bonds issued by VW and Stellantis NV, the maker of Fiat, Jeep and Peugeot cars, dominate the list of worst performers on Bloomberg’s euro investment-grade index.

That will have a large impact on the overall guage, as the automotive sector accounts for 6.4% of Bloomberg’s euro high-grade index, its second-largest segment after banking. 

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The moves come amid an earnings season that is crucial to show how robust indicators of corporate health are amid the escalating trade war. So far in Western Europe, sales have been 2% higher than analysts expected but earnings are just 0.2% above forecasts, based on data compiled by Bloomberg. That’s compared to a 1.3% sales surprise in the US and a 5.7% surprise in earnings. 

“We are still in the thick of earnings season so the questions about how companies will handle tariffs will be fast and furious,” Mike Rode, senior investment director at American Century Investments, wrote in emailed comments. 

To be sure, large parts of the European credit market have limited exposure to US exports, dampening volatility on the broader gauge. For example, utilities — many of them heavily regulated — account for a significant chunk of the index.

BNP Paribas’ Hjort said he sees tariff-related moves as an opportunity to buy, especially European cyclical names.

Another calm spot has been the UK, where sterling investment grade corporate bond spreads are flat, compared with a 3.5 basis-point jump in the euro-denominated gauge. Trump appeared to spare the UK from the threat of immediate action, saying the relationship “can be worked out.”

Still, trade war is a major risk factor even among market watchers who otherwise argue for resilient risk premiums in European credit.

“Today the news is bad and there has to be a reaction,” said Juan Valencia, credit strategist at Societe Generale. “However, we still expect spreads to remain solid over time, unless the tariffs development deteriorates and becomes a full blown trade war that pushes economies into recession,” he said.

(Updates throughout.)

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