US trade protectionism will fragment the world economy and raise the risks of a financial panic centred on the global bond market, the Bank for International Settlements has warned.
Known as the “central bank of central banks”, the BIS warned that global trade policy has deepened economic fragmentation and could feed into broader financial stability concerns.
The bank highlighted the ballooning government bond market as a major source of financial vulnerability, as owners of these assets are increasingly hedge funds that take on debt to buy bonds to benefit from small changes in prices.
The BIS said: “The post financial crisis landscape has government bond markets at its centre and asset managers of various stripes as the key intermediaries. As a result, a key risk today is liquidity stresses in government bond markets.”
Trump’s tariffs also led to bond markets being caught up in a financial storm
JIM LOSCALZO/THE MEGA AGENCY
Bond markets were at the centre of a financial storm caused by President Trump’s “liberation day” tariffs on April 2. A sharp rise in US treasury yields and a decline in the dollar forced Trump into a partial retreat by announcing a 90-day pause on proposed tariffs for most countries.
April’s bond sell-off was exacerbated by the actions of hedge funds that were dumping their holdings of US bonds. The International Monetary Fund has also warned the UK’s gilt market is more vulnerable to shocks due to the presence of hedge funds, that make speculative bets on bonds, rather than more “patient” long-term investors like pension funds.
The future of US tariffs is under question as the White House approaches its July 9 deadline, after which “reciprocal” levies are due to come into force for more than 100 countries.
If tariffs go ahead as planned, it would “represent a further step towards greater trade fragmentation. These tariffs could accentuate the decline in productivity growth as supply chains come under further pressure. Ageing populations and less migration will reduce supply capacity”, the BIS said.
“Long-standing economic relationships that have sustained global prosperity for decades are now under strain. Yet we should not look back with rose-tinted glasses. The global economy was already wrestling with structurally low productivity growth, persistently weak fiscal positions and the build-up of large and often opaque non-bank financial positions,” it said.
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The dollar has been one of the biggest losers from US trade and economic policy, falling to a three-year low as investors have sold the currency, even as stocks and bond prices have rallied in recent weeks.
The BIS also highlighted dangers in the $111 trillion global foreign exchange swap market which is dominated by dollars and shadow banks.
“Financial conditions have become more sensitive to global risk factors. This calls for a deeper understanding of the cross-border challenges inherent in a more market-based financial system and underlines the value of co-operation among central banks,” it said.