Trade and Tariffs Could Impact the Yield Curve -- Here's How

The trade war could have an indirect impact on the yield curve.
Publish date:

Let's start with this:

If tariffs Impact Economic Growth, and economic growth impacts yields, then President Trump's trade war will have an impact on the yield curve

"Trade has three impacts on the economy," Michael Kushma, chief investment officer of global fixed-income at Morgan Stanley said. 

One is "Short term economic growth." Another is "structural...productivity." "The third is just inflation -- tariffs raise prices," Kushma said. 

"If it turns out to be inflationary...the Fed would raise rates more than otherwise would happen, causing the yield curve to flatten further" Kushma said. Simply put, shorter-term rates would rise, but not necessarily longer-term rates. 

"If it {tariffs} has more growth disincentives for the economy, so the economy weakens without too much inflation, the economy may weaken, inflation doesn't go up, the Fed may pause and not raise rates," he said. 

But the Fed's job is a bit more tricky than that. It "absolutely" has to parse out tariff driven inflation, and more organic demand-driven inflation. Tariffs-driven inflation is price increases the consumer isn't necessarily pushing, which can hurt economic growth. 

For this round of tariffs, Kushma says these trade issues are hurting economic growth, which means the Fed is less likely to hike rates as a result, which could lower yields on longer term bonds. That could also cause a potentially ominous yield curve flattening. 

Check out what Real Money's saying about Trade, Tariff's and the Yield-Curve. Not a member? Sign up here.

Follow us on Twitter @TheStreet; TheStreet: Investing Strategies on Youtube or check out our podcasts on SoundCloud at TheStreetLive.