5% Treasury Yields Could Force Trump To Slash Tariffs In Q2, Says BofA's Hartnett

Increasing pressure from rising borrowing costs could soon force Washington to scale back its protectionist stance. Bank of America's chief investment strategist Michael Hartnett predicts that tariffs will decline this quarter to avoid destabilizing the massive U.S. debt funding machine.

In a note shared Friday, Hartnett said the U.S. trade deficit hit a record $140 billion in March, highlighting decades of structural imbalances that have pushed American policymakers toward a protectionist posture.

Yet, despite that deficit, the U.S. has long benefited from a financial account surplus — meaning it has consistently attracted more foreign capital than it sends abroad.

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A Tipping Point For Trade Policy?

"The flipside of big deficit… big $540 billion foreign inflows to U.S. assets past 5 years," Hartnett said, underscoring how the U.S. has been able to finance its deficits through global investor demand.

Yet that flow of funds is now at risk. Hartnett warned that the inflationary impact of tariffs, especially those imposed on April 2's "Liberation Day," combined with a weakening dollar, could force U.S. bond yields above 5%, a level that would jeopardize the long-standing strategy of deficit-financed growth.

"Nothing reverses U.S. macro policy more quickly than risk of >5% Treasury yields… why tariffs to fall in Q2," he said.

Foreign Capital: Still Flowing, But Vulnerable

Since the latest tariff announcements, there has been no clear sign of widespread dumping of U.S. assets.

Domestic institutions sold $10.3 billion, but foreign investors bought $4.5 billion, according to Bank of America data.

Still, the stakes are enormous. Foreign investors currently hold $16 trillion in U.S. stocks (18% of total), $8.5 trillion in Treasuries (33%), and $4.4 trillion in corporate bonds (27%), based on Federal Reserve Flow of Funds data.

A sustained spike in yields could scare off that capital, threatening a vicious cycle of higher interest rates and rising debt costs.

Hartnett reiterated his 2025 strategy playbook: bonds over stocks, international over U.S. equities, and gold over the dollar. That thesis, he said, rests on a shift away from the "U.S. exceptionalism" narrative of the past five years — a period that saw nominal GDP rise 50%, fueled by aggressive government spending and easy Fed policy.

Now, with no more Fed cuts, government spending growth flatlining — only rising $50 billion next fiscal year vs. $827 billion over the past year – and Trump's potential policy mix of lower immigration, smaller government, and tariffs, the macro environment is rapidly changing.

Even if the U.S. cuts its effective tariff rate from 28% to 15%, that still implies $600 billion in new tariff revenue due to the expanded base, according to Hartnett.

What’s Next For Markets?

Equities, Hartnett said, have already "correctly front-run" the expected second-quarter trade deals and tariff rollback, suggesting a potential near-term "buy the rumor, sell the fact" dynamic.

Since April 7 lows, the S&P 500 — as tracked by the SPDR S&P 500 ETF Trust SPY — has rallied 17%.

Meanwhile, the expert favors short positions on the dollar, and long 5-year Treasuries until Trump's GOP reconciliation budget formalizes future tax extensions.

He still sees the “macro catalysts” — China easing, Fed cuts, and a strong U.S. consumer — as the key forces behind any further bull run. But on the flip side, he warns that deleveraging contagion in asset markets could emerge as the most likely bear trigger, especially if Trump and Powell "lose the long end" of the yield curve.

Yields on the 30-year Treasury bond traded at 4.87% during Friday morning trading in New York.

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