One week / one topic: Deliver us from evil

What happened?

Last Wednesday, Trump shocked the world by announcing tariffs that were much higher and broader than expected.

Adding salt to the wound, the calculation methodology makes little sense (it is allegedly the result of a simple ChatGPT query) and – even more importantly – it leaves essentially no room for credible off ramps, should targeted countries even want to attempt to ‘do a deal’ with the US.

(China has already retaliated by matching the US tariff of 34% on all imported goods, plus export controls on rare earths)

As this constitutes a huge shock to global trade, equities tanked across the board and – tellingly – investors also repriced US assets sharply lower. So much for making America great again…?

While the S&P 500 and the Nasdaq are already now both in a bear market (-20%), what stands out the most to us is the sharp fall in the US Dollar.

As we know, the Dollar’s share of global currency reserves has been coming down for 20+ years but still sits at around 55%.

Following the confiscation of Russia’s Dollar reserves after it invaded Ukraine in 2022, central banks and governments around the world have gotten the message loud and clear and have started buying a lot more gold… driving its recent stellar performance.

After all – if the US President is hell-bent on tearing up the post-war world order, based on security guarantees and free trade – should you really be holding as much of your assets in Dollars?

For now, the short-term impact is already estimated to push the effective tariff rate to 22.5%, amounting to an immediate tax of $700bn on US consumers and firms for a contractionary shock of 2.3% of GDP… even before taking into account any retaliatory measure from affected countries.

Is this the final nail in the coffin for the ‘US exceptionalism’ credo?

If we have officially entered a new era of economic warfare and de-globalization, should investors then radically review expectations of continued growth and brace for recession instead?

Our observations

• Fundamentals: The unstoppable, multi-decade rise of foreign inflows into US assets (below) might have finally met its demise in the Trump administration. Maybe markets will eventually force a reflexive change in the policy mix… Should they fail, look out below.

• Price action: The immediate price reaction was large but relatively orderly, with sharp moves at the equity index level and short-term government bonds rallying significantly. Mag 7 stocks might suffer further as they make a juicy target for European retaliation.

• Investor beliefs: Even if ‘foreigners’ conclude that the US is not a safe place to park their capital anymore, the ultimate test will be domestic investors… Nobody voted for a sharp haircut to the value of their 401k, but the strike of the ‘Trump put’ might be much lower than where we are today.

So what?

Trump is by now well-known for negotiating via extreme offers and concurrent attempts to leverage unpredictability. The problem is that America cannot afford to break global investor trust (h/t Davide), especially when it needs foreign investment to finance its huge and growing imbalances.

Furthermore – even if foreign countries were inclined to negotiate after being accused of “looting, pillaging, raping and plundering” – the bizarre tariff calculations methodology leaves very little to actually work with. Simply put, you can’t suddenly tear up and remake how global trade works overnight…

Adding to the overall perception of ‘lack of seriousness’, Trump’s team has used tariffs as the blank canvas upon which to project whatever was the ‘flavour of the month’ – as per the below from my friends at Epsilon Theory. (an absolute must-read)

When it comes to portfolio positioning, we retain our bias towards non-US equities after having also trimmed risk earlier in the year.

Government bonds remain in our view an attractively-priced form of portfolio insurance, and we still have a preference for long-dated US Treasuries as we think that ‘no atheists in foxholes’ considerations would ultimately prevail over fiscal concerns in a true crisis.

Credit remains unattractive given (still) very tight spreads, while local currency EM bonds have proved resilient in this phase and still look attractive as medium-term return generators.

Mood music: The Cardigans – Lovefool