Tariffs lead to flight-to-safety rally for bonds

Municipals rallied Thursday, with yields falling in sympathy with U.S. Treasuries in a flight-to-safety move away from risk assets, while equities tumbled a day after President Donald Trump announced massive tariffs on nearly all imported goods from other countries.

"With the initial announcement proving to be more aggressive than expected, the market responded overwhelmingly negatively, with stock futures trading lower and the U.S. dollar weakening further," said Seema Shah, chief global strategist at Principal Asset Management. "U.S. Treasuries have rallied ? as the market tries to digest the conflicting growth and inflation impacts."

Under Trump's sweeping new tariff measures, the U.S. will impose a 10% tariff on all imports from all other nations, starting April 5, with higher reciprocal tariffs on "specified trading partners deemed to have excessive tariff or non-tariff barriers," from April 9 onward, said UBS strategists.

At noon Thursday, munis rallied as yields were bumped up to 12 basis points, depending on the curve, while UST yields rallied, with yields falling 13 basis points on the short-end.

Munis are moving in sympathy with what's happening with the Treasury markets, noted Cooper Howard, a fixed income strategist at Charles Schwab (SCHW), as investors look to bonds as a safe heaven.

"Munis are a safe haven, because although they're not the most liquid, they also tend not to lose value, so it's not unreasonable to sell stocks and buy munis just to preserve principal," said Matt Fabian, a partner at Municipal Market Analytics.

Munis rallying "makes sense" if tariffs will put the country into a recession, but less sense if tariffs raise costs, "which they seem to be doing," and are inflationary, he noted.

Most strategists, though, do not expect a recession.

"These tariffs alone are not enough to tip the U.S. economy into recession," said ITR Economics economist Lauren Saidel-Baker. "Tariffs will cause a slower rate of growth, but the U.S. macro economy will still expand in 2025 and beyond."

However, "the combination of slowing growth and rising inflation creates an increasingly uneasy macro environment ? one that bears some resemblance to stagflationary conditions, even if it doesn't fully meet the definition," said Principal Asset Management's Shah.

"The difficult thing about it is coming into the announcement, there are already signs that the economy might be slowing, that inflation might not be coming down to the Fed's 2% target as quickly as expected," Howard said. "So this has an element of adding to the stagflation."

As tariffs pose a significant stagflation threat to the country in the long term, Fabian said, it's unclear what type of performance bonds would offer in the medium term.

"The market sentiment is just confusion, fear, and also wait-and-see what's going on," said Alice Cheng, director of municipal credit and investor strategy at Janney.

"The market right now is a little bit hard to gauge because there are so many different things going on," she said. "The biggest fear is how this impacts our infrastructure and capital projects? And essentially how does that affect credits? And the credit qualities and financing infrastructure that we need going forward, can issuers absorb all the rising costs? Would they be passing it down to consumers or taxpayers? You know which sector will be impacted the most?"