The 30-year Treasury yield was firmly above 5% the last time I looked, at the highest since 2023 after a weak auction of 20-year debt. I am now officially worried about US bonds.

Just last week, I was saying the downside risk from the tariff and economic picture hurts equities more than bonds. But the downgrade of the US credit rating by Moody’s Ratings and the high-deficit budget being crafted in Congress have changed my view.

All US financial assets are in jeopardy here: from Treasuries to corporate bonds to equities. Even the dollar is under threat. Hard assets will win in this environment. Here’s a brief synopsis of why:

1. All else equal, a high-tariff economic policy hurts either margins or revenue growth, putting downward pressure on equity valuations.
2. But a budget laden with tax cuts offsets some of that, lessening the chance of recession, but also increasing likely inflation, something that is toxic for both equities and bonds.
3. That’s bad news for getting mortgage rates down, and therefore weighs on house prices.
4. In a best-case scenario, the US economy can get through this without a recession. That would mean the kind of slow growth and higher inflation that keeps a lid on equities and Treasuries without necessarily causing damage to credit. A recession would change that.
5. Finally, given the lower US credit rating, foreign investors have an incentive to sell US assets, putting the so-called ‘Sell America’ trade back on the table. Hard assets may be the winner in this environment.

Think of fiscal stimulus as an offset to tariffs

Listening to US President Donald Trump, the sense I get is that he’s committed to tariffs as a policy tool and is now looking for ways to offset the dampening effect on growth. The thinking is likely that higher tariffs will reduce bilateral deficits while also protecting US manufacturing jobs, and perhaps bringing employment back to the US. That’s a framing I don’t agree with because I look at high tariffs as unwanted economic friction that will do more to lower growth and raise inflation than create a manufacturing renaissance in America.

Still, it’s clear that Trump recognizes that tariffs will slow growth. And he has been looking at monetary and fiscal policy as ways to offset that. He began by pressuring the Federal Reserve soon after he unveiled his so-called reciprocal tariffs. When this hurt the prices of both stocks and bonds, Trump turned to Capitol Hill, trying to get Congress to pass legislation that will reduce taxes. The overall goal appears to be to create a tariff barrier for US firms to compete behind, but to avert a recession through other policy means.

Even if the US avoids a recession, the reality is that many goods will still be imported at higher prices. And firms have to either absorb the cost of those prices, pass the inflation on to customers or some combination of both. And so that means margin compression or lost sales for many companies and lower earnings growth overall for the S&P 500 Index.

The S&P 500 trades higher than on April 2 when Trump announced steep tariffs. So I outlined last week that this disconnect between the changed macro environment and elevated valuations presents considerable downside risk for US equities.

The Trump administration presumably knows all this and wants to ensure it doesn’t get blamed for overseeing a bad economy. That’s why we see the president on Capitol Hill trying to get Congress to pass a bill that adds an estimated $3.3 trillion to the federal deficit through 2034. If the US has a recession in that timeframe, those numbers should be expected to be higher still.

Moody’s has been watching all of this unfold and finally decided it had seen enough. It stripped the US of its top Aaa rating on Friday, joining the other two major ratings companies. The firm said it expects federal deficits to grow to nearly 9% of  gross domestic product by 2035, up from 6.4% last year.

The downgrade doesn’t change the situation materially. It’s more a marker of what we already know about the dysfunction in US governance, higher deficits, slower growth and higher inflation. If Congress passes the tax cuts though it lessens the chance of recession, shifting some of the downside asset-value risk from equities to bonds as it means higher interest rates, an outcome the downgrade has only accelerated.

Tax cuts are a temporary salve. Eventually the risks will shift back to equities when the economy inevitably turns down. As we know from the late 1960s and 1970s, stagflation leads to a more volatile economy with shorter business cycles that are toxic for asset prices. And so all US assets will come under pressure unless the economic formula changes.

What about other assets?

I’d mention two other major asset classes here: housing and credit.

For housing, let’s go back to 1970s era stagflation. Looking at median US house prices from the census, in 1970 the average was $23,000. But the price rose to $64,000 by 1980 for a compound annual growth rate near 11%. That’s clearly more than the inflation rate, which made houses a good place to beat out inflation back then.

Using housing as an inflation hedge didn’t come without some problems. For one, house prices were flat to negative in real terms from 1978-1981 during the worst of stagflation and during the highest interest rates. The other issue — which is also problematic today —  is that house-price inflation represents a transfer from the house-poor to the house-rich. Those who can’t get on the property ladder are losers in this equation. With 30-year mortgage rates edging closer to 7% recently, that will leave many would-be homeowners out of luck.

The other asset class that US households have large exposure to via their 401(k)s and pension plans is credit. For that, I’ll outsource my comments to Jamie Dimon, CEO of JPMorgan Chase, the only big bank chief who helmed his institution during the last credit crunch nearly two decades ago.

“Credit today is a bad risk,” he said at the firm’s investor day on Monday. “The people who haven’t been through a major downturn are missing the point about what can happen in credit.”

Essentially, credit can do fine if the economy holds. But as soon as we get a recession, things fall apart. Dimon says credit spreads aren’t adequate to compensate for the potential of an economic downturn.

So when you think about where the risks are now, housing looks like a relative bright spot. Treasuries, credit and equities all have risks that housing can help overcome. And those financial assets come with another risk too: the ‘Sell America’ trade.

I thought it was interesting that pension-fund managers in Hong Kong were flagging the risk they would be forced to sell their Treasury holdings after the US downgrade by Moody’s. Apparently funds operating under the city’s Mandatory Provident Fund system can’t invest more than 10% of their assets in Treasuries unless the US has a AAA or equivalent rating from an approved ratings firm. There’s a Japanese ratings company that still rates the US as AAA. But the writing is on the wall. I think many non-US investors will trim their exposure to Treasuries if they can.

I expect that such a move would be dollar-negative more than Treasury-negative, simply because long-term yields reflect mostly the market view of future short-term rates. And the downgrade doesn’t change that view. US buyers can always step in to buy when foreigners sell. But to the degree Treasuries are seen as a weaker credit, it undermines faith in US assets and should push the dollar lower. Plus, the greenback is overvalued in terms of purchasing power. And so, its natural tendency is lower — which also will spur foreigners to reduce financial asset holdings that are in dollars.

In sum, the near future looks to be one where real assets that hold their value are the winners more than financial assets that fluctuate with the economy. That’s great for America’s home-owning middle class. Unfortunately, it’s another obstacle for the millennial generation which has already lived through a lot of turbulence in markets and elsewhere.

Quote of the week

Things on my radar

• 2025 has been a roller coaster for investors, And with roller coasters “there’s always more than one plunge, and the steepest always comes last.”
• Retail investors might tell you they’re doom and gloom. But they’re the ones buying the dip.
• The US risks “ fiscal disaster” if a recession hits.

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