Credit investors are facing a conundrum as the Trump administration turns tariff threats into reality: Sell bonds in exposed companies and avoid further losses or have faith in their fundamental health.
The knee-jerk reaction has been to sell. More than three-quarters of U.S. 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 U.S., a gauge of credit risk rose the most intraday since last Monday’s global market rout, reflecting fears that tariffs will reboot inflation.
-Real-time market data on BNNBloomberg.ca
-Latest updates in Trump’s tariff trade war
The tariff news brought more uncertainty to an already-fragile global credit market, which had just recovered from a rate-volatility scare last month. Credit investors now need to evaluate how far and fast a trade war between the U.S. and key partners could escalate, and whether the impact may be inflationary enough to change the trajectory of central bank interest rate decisions.
“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.”
The U.S. announced 25% tariffs on Canada and Mexico, its neighbors and main trading partners, over the weekend. The levies are set to take effect on Tuesday, barring a last-minute deal. In comments to reporters, President Donald Trump said that tariffs targeting the European Union “will definitely happen.”
Top of mind for investors is how the announced and future tariffs may affect interest rates. Tariffs could fuel inflation in the U.S., making the Federal Reserve more careful about lowering rates, while restrictions on European exports could spur the European Central Bank to cut rates even more aggressively than already expected. That dynamic has left the euro approaching parity with the US dollar.
In credit, the cost of protection against defaults by investment-grade firms in Europe is rising the most this year, even though it’s still low by historical standards.
Investors are also weighing up where tariffs may hurt the most. In Europe, internationally-exposed carmakers — already a pain point for corporate bond investors in previous months — are taking the biggest hit. Bonds issued by VW and Stellantis NV, the maker of Fiat, Jeep and Peugeot cars, dominate the list of worst performers on Bloomberg’s euro investment-grade index.
That has a big impact on the overall guage, as the automotive sector accounts for 6.4% of Bloomberg’s euro high-grade index, making it its second-largest segment after banking. In the US gauge, they are further down the pecking order with 2.5% of index weight.
The moves come amid an earnings season that is crucial to show how robust indicators of corporate health are amid the escalating trade war. So far in Western Europe, sales have been 2% higher than analysts expected but earnings are just 0.2% above forecasts, based on data compiled by Bloomberg.
“We are still in the thick of earnings season so the questions about how companies will handle tariffs will be fast and furious,” Mike Rode, senior investment director at American Century Investments, wrote in emailed comments. “More extreme tariffs” equal more uncertainty, which means higher volatility, he wrote.
To be sure, large parts of the European credit market have limited exposure to US exports, dampening volatility on the broader gauge and giving investors a safe haven. For example, utilities — many of them heavily regulated — account for a significant chunk of the index.
BNP Paribas’ Hjort said he sees tariff-related moves as an opportunity to buy, especially European cyclical names.
Another calm spot today is the U.K., where sterling investment grade corporate bond spreads are flat, compared with a 3.5 basis-point jump in the euro-denominated gauge. Trump appeared to spare the UK from the threat of immediate action, saying the relationship “can be worked out.”
And at the moment, rates traders still expect the Fed to cut rates at least once by 25 basis points this year, even though they tempered their policy easing expectations since Friday.
Still, the trade war is a major risk factor even among market watchers who otherwise argue for resilient risk premiums in European credit.
“Today the news is bad and there has to be a reaction,” said Juan Valencia, credit strategist at Societe Generale. “However, we still expect spreads to remain solid over time, unless the tariffs development deteriorates and becomes a full blown trade war that pushes economies into recession,” he said.
©2025 Bloomberg L.P.