A Big Shift Is Happening in the Bond Market

Investors are shifting bond strategies as President Donald Trump's Liberation Day tariffs upend traditional monetary policy expectations, according to State Street Global Advisors' Q2 Bond Market Outlook published Wednesday. With tariff uncertainty fueling market volatility, bond investors are seeking ways to build more resilient portfolios amid unprecedented market conditions.

Monetary policy typically drives bond market trends, and 2025 began with the usual investor debates over potential Federal Reserve rate cuts, according to Matthew Bartolini, head of SPDR Americas research at State Street. However, President Trump's higher-than-expected Liberation Day tariffs disrupted market norms, sinking stocks and triggering a bond market selloff.

Although the administration paused the tariffs just one day after implementation, the market chaos has already resulted in forecasts for lower global growth and higher inflation while exacerbating uncertainty over rate cuts, according to the State Street report.

In this unstable environment, investors need to rethink traditional bond strategies that primarily focus on potential rate cuts, instead prioritizing portfolio diversification and resiliency to navigate an increasingly unpredictable market landscape, Bartolini emphasized in the outlook.

Tariff Impact Reshapes Economic Forecasts

With the Liberation Day tariff announcements, 93% of economists are lowering their GDP forecasts, 87% anticipate rising inflation and 76% acknowledge increased uncertainty for businesses and consumers, according to Bloomberg data cited in the State Street report.

These negative trends were already emerging before April 2, the outlook explains. At its March meeting, the Federal Reserve downgraded GDP estimates, raised unemployment forecasts and increased expected inflation figures.

Consumer sentiment has also deteriorated, tumbling to a two-year low while inflation expectations jumped to a 32-year high, Bartolini pointed out. Job separation readings reached their worst level since 2020, personal spending expectations dropped by the most since 2021 and the outlook for personal finances hit a record low.

Adding to these concerns, U.S. factory activity contracted for the first time this year, with the Institute of Supply Management's Manufacturing PMI declining to 49, below the 50-point threshold, indicating contraction, the report states. The group's price measure increased to its highest since June 2022.

Over the past six months, expectations for Fed rate cuts have fluctuated dramatically—from four cuts to no cuts to one-and-a-half cuts by the June 2025 meeting, Bartolini wrote. Current forecasts project four cuts for all of 2025, up from February's expectation of just two.

Strategies to Enhance Portfolio Resiliency

Rather than moving to cash, which would see diminishing returns if the Fed cuts rates as expected, Bartolini recommended three key strategies to enhance portfolio resiliency: exposures that react positively to falling growth and rising inflation, active strategies targeting absolute and relative value opportunities, and growth-biased credit allocations in portions of the portfolio.

Specifically, the State Street report suggests investors consider inflation-linked bonds, which benefit from both falling growth and rising inflation pressures. These instruments have "a positive bias to falling growth—as the safety of bonds is sought in periods of economic malaise—as well as rising inflation given the inflation adjustments."

Active core-plus strategies offer another advantage during this period of volatility: providing flexibility to manage rate risks while pursuing opportunities across a broader universe, Bartolini noted. These strategies can tactically adjust duration and implement yield curve trades to seek alpha in rapidly changing conditions.