One week / one topic: Ventriloquism

What happened?

You could argue that through tariffs – in typical Trump fashion – the President has found a way to (partially?) usurp the Fed’s ability to affect macro conditions in real time.

Now – by openly and repeatedly criticizing Chairman Powell, and indulging on (if not directly feeding) speculation on who he will appoint next – Trump is also effectively making him a lame duck.

As financial markets look to discount future developments and Powell’s term is naturally set to end in 11 months anyway, what really matters now is that Trump is going to appoint whoever he thinks is going to do his bidding… Namely, in the form of cutting interest rates pretty much regardless.

Goodbye, central bank independence?

Of all the ways in which such a development would be of great importance, price action is clearly pointing towards US Treasuries and the Dollar as the immediate potential victims of this.

At first, one might think that lower policy rates would bring yields down (which is likely what Trump would hope for) but the recent evidence actually points to the contrary…

If we define fiscal dominance as “an economic condition that occurs when a country’s debt and deficit levels are sufficiently high that monetary policy ceases to be an effective tool for controlling inflation” (Daniel J. Ford), this is looking a lot like it…

Furthermore – as we have previously considered – the status of the Dollar has already been affected (perhaps irreparably) by the events and declarations of the last few months.

Even the ECB – which is, arguably, a purveyor of competing goods in the form of the Euro – is pointing out that investors are more and more skeptical towards holding reserves in Dollars (and other fiat currencies) as opposed to hard assets like gold.

Inspecting recent price action more closely, we can see that Bunds – after digesting the abandonment of the German ‘fiscal brake’ in March – have been performing strongly.

On the other hand, US Treasuries have visibly suffered since President Trump’s tariff announcements. Even on Friday – when Israel attacked Iran – US yields went up, and up more than most other developed markets government bonds…

No matter what you think is behind this decoupling in performance between US Treasuries and Bunds – noise, repatriation of capital, fiscal concerns, economic nationalism, etc. – price is ultimately the closest thing we have to something ‘true’, and you have to respect that.

So, what does it mean for portfolios overall?

Our observations

• Fundamentals: Germans might have abandoned their 2009 rule restricting annual structural deficits to 0.35% of GDP, but they are simply not going to suddenly become anywhere near as profligate as Americans… Nobody knows where the line is, but at some point fiscal concerns do matter.

• Price action: The relative outperformance of Bunds is confirmed by the Euro, which has been on a tear pretty much since it was clear that Trump was going to win.

• Investor beliefs: Investors have taken notice of the Draghi report, the von der Leyen-Lagarde blog and the rush towards further European integration (also) in the name of national defense. This might all take a long time to fully play out, creating long-term investment opportunities across asset classes.

So what?

We have recently shifted our government bond allocations from a mix of nominal US Treasuries and UK Gilts to a more diversified basket, also including German Bunds plus US and UK long-maturity inflation-linked bonds.

While keeping portfolio duration unchanged at ~3.6 years, this achieves a 30% duration contribution from inflation-linked bonds and also an even geographical split across US, UK and Germany.

For the purposes of implementing the optimal ‘portfolio insurance policy’, we believe this is a more appropriate allocation in light of the observable dent that Trump’s actions have put into the allure of US assets.

Over to you, Mr President…

Mood music: Paul Simon – 50 Ways to Leave Your Lover