(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.
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.”
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.