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What Made Trump Blink First….?

We think the Treasury market was the ultimate impetus behind the 90 day pause in reciprocal tariffs. Why?

Let’s get back to macro theory.

If there’s a “normal” negative shock to the U.S. economy — say, a spike in oil prices — and it really only impacts companies’ growth projections, what should happen?

➡️ Equities should get hit. S&P down, NASDAQ down, Russell 2000 down, etc…not pleasant, but all to be expected.

➡️ Corporate credit spreads also probably widen. Why? Well, if it’s more expensive for companies to make the goods they sell, and they can’t grow as quickly — or need to shrink — that impacts their ability to repay their debt, and should make it more expensive for them to borrow (all else being equal).

➡️Investors will then reallocate their money out of riskier assets (like equities and corporate credit) into safer assets, like U.S. Treasuries.

Remember, U.S. Treasuries are bonds issued by the U.S. government, and carry zero risk of default — in theory. Why can’t the U.S. default on its bonds? Because we issue bonds in our own currency, and we can print more of our own currency to pay back those debts if absolutely necessary.  

This risk allocation is what we’d expect for a normal shock to the equity markets.

This is not what we saw this past week.

Instead of a flight to quality trade, where investors selling out of U.S. Equities move their money into Treasuries…Treasuries sold off, too.

In fact, pretty much everything that was denominated in U.S. dollars (including the U.S. dollar itself) underperformed.

Why are Treasuries the canary in the coal mine?

Well, over the past half a century of liberal* trade policies (*meaning, relative to protectionist), we’ve been flooding our trade partners with US dollars in exchange for their goods.

And since the middle of the 20th century, the U.S. dollar has been the global reserve currency.

What do foreign countries do with all those U.S. dollars?

They buy U.S. dollar denominated assets — specifically, U.S. Treasuries.

As of Q4 2024, foreign investors currently own about 23.4% of US Federal debt.

So why might a global trade war negatively impact more than just equities?

➡️ If foreign investors liquidate their holdings either out of lack of confidence in the U.S., fears of inflation devaluing the dollars they receive, or more sinisterly, to retaliate against U.S. policy, that should cause rates to sell off.

➡️ If rates sell off, it makes it more expensive for the U.S. government to fund itself when it issues new debt, which it already does every week just to stay running.  Every month, the Treasury holds a series of staggered auctions, issuing new debt in maturities ranging from four weeks to 30 years.  

➡️At those auctions, foreign governments are usually large participants in buying new bonds. They often (though not always) participate as “direct bidders”, and direct bidders tend to range from about 10-30% of the auction takedown, depending on maturity.

➡️ If those bidders do not show up at U.S. Treasury auctions, that debt likely gets issued at much higher rates. U.S. Treasury auctions are DUTCH auctions. So if $25bn 10YR notes are being auctioned off, the auction stops at the lowest yield someone is willing to accept for the $25,000,000,000th 10year note — no lower.

➡️ Tuesday’s 3YR auction saw the lowest direct bidder participation since COVID. Wednesday’s 10YR auction saw direct bids of 1.4% vs. an average of 17.5%. By comparison, after the 90 day tariff pause was announced, today’s 30YR auction saw high direct bidder participation of 25.8%!!

If the interest rate on US Treasuries increases beyond a certain point without sufficient growth to pay down our debts, the end outcome is a debt trap.  Debt traps occur when you need to issue new debt just to pay down the interest on your existing debt, let alone pay off existing debts.

The history of countries that have found themselves in debt traps is not pretty.  

So, if you’re not watching Treasury auctions…or you think all you should care about is the equity markets right now…think again.

To give you a sense of how exciting Treasury auctions can be, take a look at the price action for today’s bond auction:

That giant cliff at 1pm EST? That’s when the auction stopped through, meaning: bonds were issued rich relative to where they were trading going into the auction, signaling stronger demand than the market anticipated, with HIGH direct bidders relative to the past two auctions.

Perhaps a message from foreign investors after the 90 day tariff pause…play nicely and we’ll buy your bonds? 🤷‍♀️

Why Private Equity Was a “Panican” over Tariffs

At first glance, you might think private equity firms wouldn’t be too fazed by Trump’s proposed tariffs. After all, PE is a long-term, illiquid asset class. Investors can’t check their performance minute-to-minute like they can with public stocks.

But you'd be wrong.

The tariff chaos had private equity pros sweating—and for good reason. There were four major ripple effects that made PE firms nervous:

1. No Exits = No Payouts

Private equity firms rely on IPOs and M&A to cash out of their investments (meaning the companies they bought and theoretically “turned around”), and return money to their investors or LPs. Exits were very light over the past few years and PE firms were banking on the new administration to reopen the M&A and IPO market.

But the tariff headlines threw cold water on that. Markets got shaky, and IPOs and M&A deals that were supposed to go live in the next few months had to hit pause.

No exits = no liquidity. That’s a big problem for firms looking to return capital which in many cases their investors — pension funds, endowments, foundations — needed. Which brings us to the next issue…

2. The Denominator Effect Hit Hard

Big institutions — think pension funds and university endowments — invest in private equity as part of a diversified portfolio. Picture a pie chart with slices for stocks, bonds, real estate, and PE:

Now imagine the public markets tank. Stocks get marked down instantaneously, so the "pie" shrinks. But private equity doesn’t get revalued as quickly. Its slice stays the same— or at least appears to.

Suddenly, what was supposed to be a 10% allocation to private equity looks more like 15%.

That’s called the denominator effect. They’re suddenly even MORE overexposed to private equity without actually buying more. AND many limited partners (aka LPs) had come into this year already over their PE risk limits. It led to many frantic calls to PE firms looking to sell their GP stakes.

3. Portfolio Company Performance 

Because of the magnitude and extent of the proposed tariffs, almost no company would be spared performance-wise. As PE firms think about the future cash flows of their businesses, tariffs hit on multiple fronts. 

• Lower Margins: Proposed tariffs would have meant higher costs as the price of imported materials rose.

• Lower Growth: Between lower profits and therefore a likely need to INCREASE costs, that impacts demand for products, not to mention retaliatory tariffs from other countries hurt the demand as well. All in all results in lower growth

• Borrowing costs: See ripple effect 4.

4. Corporate Interest Rates Rising

Now partly because of the risk outlined in #3, this means companies will have to pay more for their debt, which REALLY impacts companies that already have a lot of debt like…companies owned by PE firms.

When companies borrow, they pay an interest rate that is made up of:

Risk-Free Rate (like U.S. Treasuries or SOFR) + a Credit Spread

The credit spread compensates lenders for default risk, which just means what is the risk of not being able to make interest payments. 

Here’s a quick example of how it works:

• Treasury yield = 4.0%

• Spread = 1.5%

• Borrowing cost = 5.5%

If the company looks riskier, credit spreads widen, meaning their overall interest rate goes up.

And if Treasuries sell off (as discussed in our first article), those rates go up too, meaning their overall interest rate goes up EVEN MORE.

Companies with existing debt have an additional problem: their existing debt has “debt covenants” in place.

Debt covenants are just rules that are put into the credit agreement a company has with a bank that serve as an early warning signal about whether a company is at risk of default. If they trip a covenant, in many cases they may need to re-negotiate terms of their existing debt.

One common example of a covenant is a restriction on how much LEVERAGE a company can take on. For example, a covenant may say “You must maintain a leverage ratio under 6x”. How does this work?

Let’s say a company has:

• $400M in debt

• $100M in EBITDA → Leverage = 4x (<6x, so we’re safe!)

However, if because of tariffs earnings drop to $50mm because, this is what happens

• $400mm ÷ $50mm = 8x leverage → They’ve breached their covenant despite not borrowing a dime more.

And again, covenant breaches can lead to forced restructurings, where our company is now far riskier with higher leverage levels and lower profitability. It’s just bad all around..

Bottom Line:

The tariff headlines didn’t just shake up public markets — they rattled private equity too. Now with the 90-day pause in place, everyone’s hoping for calmer waters.

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But with so much uncertainty, Private Equity isn’t popping the champagne — or domestic sparkling wine — just yet.