Are markets bringing Trump to heel?

The president has retreated in battle but he could go on the front foot again!

Financial markets recovered losses during the past week, when initial fears that Trump was positioning to remove Jerome Powell were allayed by a subsequent statement that the President has no intention of firing the Fed Chair.

Trump has made no secret of his desire to see interest rates come down, yet with his own policies pushing inflation higher, it is not surprising that the central bank has been treading a more cautious line on monetary policy, even as it eyes building downside risks to growth.

Indeed, with the Fed cherishing its independence, there is a sense that Trump’s interventions make it even more unlikely that the FOMC will lower rates in the near term, lest it be seen to be giving in to Presidential influence and manipulation.

In this respect, it seems inevitable that Trump’s anger will be directed towards the Fed in the coming months, as the economy slows. However, with financial markets not taking kindly to the idea of POTUS undermining the autonomy of the institution that acts as ultimate guarantor and custodian for financial stability, it seems that the President may need to remain content with heckling from the sidelines, rather than intervening directly.

In this way, there is a sense that financial markets are acting as a constraint on Presidential power. Coming in the wake of Trump needing to announce a 90-day pause on additional tariffs earlier this month, it seems reasonable to conclude that rather than there being a 'Fed put', which may trigger the FOMC to ease policy in response to market price action, there is more of a 'Trump put' coming into focus, in which disruptive policies may be pushed back or watered down, should market price action veer towards a 'sell America' trade in global markets.

With respect to trade, there is also a growing sense that the period of rapidly escalating mutual tariffs between the US and China has gone too far, and there needs to be a compromise to reset at levels that mitigate economic damage. Since the Liberation Day announcements, shipping of goods between the two nations has largely collapsed. By the start of May, it will be apparent, as US ports run empty and truckers are left idling their wagons with nowhere to go. The damage to supply chains can be very disruptive to economic activity in the short term.

Similarly, shortages of components can end up adding to prices, which are already being driven upwards, as the dollar sinks in the wake of overseas capital turning away from the country. In this respect, although we doubt that Washington will shift from its firm desire to end US dependence on China, and there is unlikely to be much meaningful rapprochement between the world’s two largest economies, a more pragmatic approach may allow for a more gradual realignment of production and supply changes, mitigating the potential shock therapy from a ‘cold turkey’ scenario, in which trade comes to a sudden and abrupt halt.

We will be meeting with policymakers and advisors in Washington next week and will be testing our thesis with respect to how trade and tariffs are resolved looking forwards. In this respect, it has been our belief that, ultimately, we will see tariffs legislated through Congress in the context of the Budget, allowing for the revenues raised to reduce taxes elsewhere. A 10% universal tariff (ex-China) would feel like a reprieve at this point and could create a backdrop for a more encouraging outlook into 2026. From this standpoint, we have viewed additional tariffs via executive orders to represent more of a bargaining stance.

Yet with the Trump administration badly mishandling and miscommunicating its tariff policies, this has greatly undermined the ability of the US to negotiate the outcomes it might have hoped to otherwise achieve. Consequently, we have thought that additional tariffs may end up pushed back even further than the 90-day hiatus, with much of what was outlined on April 2^nd not ever seeing the light of day.

Assessing US markets, we continue to see fair value for US 10-year Treasuries around 4.5%, at a time when cash rates continue to sit at 4.3%. We would be better sellers of duration below 4.2% on 10s and more constructive on yields above 4.8%. Meanwhile, we look for the US yield curve to steepen over time, as we believe that a greater term premium is required.

However, in the absence of rate cuts, we think that the front end of the US curve is already fully priced and that unless short-dated bonds can rally, this will contain the extent of curve steepening, for the time being.

Currently, we see most value in the US curve in US TIPS. We believe that recent macro developments will push inflation higher and therefore the recent decline in inflation breakeven rates is counterintuitive, in our view. In light of this, we have added exposure in TIPS in the past week. On an absolute basis, we think that real yields should trade below 2% in the 10-year part of the curve.

Elsewhere, policy developments have triggered a significant realignment in FX, with the US dollar weakening materially against nearly all currencies this month. A loss of credibility in US policymaking has seen bonds, stocks and FX all drop, meaning that overseas investors have incurred substantial losses on their dollar-based assets, prompting a degree of soul searching with respect to asset allocation.

With US policy actions prompting varying degrees of anger and resentment around the globe, we have already witnessed consumers look to boycott the US. In this context, this may apply to capital allocations as well. In this way, it would be hard not to rationalise that the ‘marginal’ dollar is now less likely to get invested in US assets or the US currency going forward, now that US growth exceptionalism has faded and the assumed wisdom of piling into US stocks has been challenged. 

Asset allocation shifts play out over quarters and years, rather than in the space of a few weeks. However, in meetings with Asian investors, it has been interesting to observe how many are structurally over-allocated towards the US dollar, and now appear to be re-considering this bias. Therefore, it is tempting to think that, whereas the dollar has been a multi-year beneficiary of international capital flows in the recent past, we may have witnessed an important inflection point that could herald an extended period of dollar weakness.

In FX, we have continued to favour the yen since the start of this year and continue to maintain this preference. Having rallied from levels close to 160 just a few months ago, 140 may represent an upcoming test for US$/yen. Yet we would note that with the yen stable against the euro and many other major currencies, the move to date has been all about dollar weakness rather than yen strength.

In the near term, we would observe that shorter-term investors have jumped on board US$ weakness in the past couple of weeks and positioning against the greenback may have become over-extended. Consequently, it may make sense to be patient, before adding additional short dollar positions. For example, we would look for a retracement to 1.12 or lower, before extending short dollar risk in crosses such as euro/US$, in a portfolio context.

European markets have followed in the wake of overseas developments in the past week. That said, it has been interesting to note that day-to-day price action appears to be becoming less dependent on US moves, as correlations diminish. In light of this, there have been a number of recent instances where Eurozone yields have risen on the day, just as those in the US have fallen (and vice versa), injecting increased volatility into cross-market spreads.

Elsewhere, in the UK, a reduction in long-dated 30-year bond supply in the revised gilt issuance remit from the DMO saw the long end of the curve rally somewhat, having been a short position targeted as a point of vulnerability by a number of hedge fund investors.

In our own meetings with UK policymakers, we continue to advocate the Bank of England stops QT gilt sales and takes steps to make it more attractive for banks to own gilts rather than interest rate swaps, in order to further help yields and reduce the pressure on the Labour government, against a challenged macro backdrop.

In Japan, the focus has been on talks seeking to strike a trade deal to lower tariffs. We remain inclined to think that the US is eager to have a close relationship with Japan, given its strategic importance in the Pacific. Both Washington and Tokyo would like to see a stronger yen.

Meanwhile, with Japanese inflation remaining consistently above 2%, we have seen ongoing normalisation of interest rate policy coming from Tokyo. In this sense, any agreement seeking to push the yen stronger and Japanese rates higher is consistent with this trajectory.

At a time when we see domestic Japanese investors increasing allocations towards Japanese bonds and stock in the new fiscal year, we look for flattening at the long end of the Japanese yield curve, as shorter-dated yields rise. We also view 30-year JGBs as cheap on an outright basis, with absolute yields above 2.7%, putting these close to the valuation on 30-year German bunds.

Corporate CDS indices such as Itraxx crossover have now retraced just over half of the widening seen at the start of the month, outperforming the comparable CDX High Yield Index in the US market.

In both markets, CDS spreads have rallied more rapidly than cash bonds as the market has turned, meaning a widening in the basis between CDS and cash securities. Having partially lifted CDS hedges in the widening in the middle of this month, this has benefitted returns, though at the time, we did not close all hedges given the backdrop of elevated volatility. That said, should CDS spreads continue to march tighter, we think that adding hedges back may now be the next move to consider, given the more challenged landscape for growth that lies ahead of us.

Looking ahead

We are inclined to think that we could be moving into a somewhat more settled period, if Trump is being restrained by markets. However, inasmuch as Trump is pushed to back down, what we may witness may mark more of a retreat than a surrender.

Arguably, if risk appetite recovers sufficiently, then we would not rule out Trump going more onto the front foot once again, and from this standpoint, it feels like we need to be relatively cautious in building positions and to have clear targets in mind to reduce risk, in anticipation that another bout of volatility may not be that far around the corner.

Meanwhile, it is interesting to reflect upon Elon Musk pulling back from DOGE, in order to refocus his efforts on Tesla, following a 71% slump in its profits. There is a sense that Musk’s star has fallen a long way since he paraded his son on his shoulders in the Oval Office, just a few weeks ago. His exit leaves much of the DOGE agenda in limbo and we would continue to question how successful this administration will actually be, in terms of making substantial cuts to the Federal cost base.

There is a sense, perhaps, that Musk became intoxicated by the scent of power and inevitably flew too close to the sun. Yet, as for Tesla, it may be questionable whether the return of its CEO will mark a turning point following a troubled chapter, and we note that many of the problems that the company now faces around brand image are very much a direct consequence of the actions of its own CEO.

Elsewhere, we will be paying careful attention to upcoming economic releases. To date, hard data has been holding up well, with all the weakness shown in soft date releases pertaining to sentiment-based surveys. Yet this is likely to change meaningfully in the next few weeks, as the effects of the economic disruption unleashed by this administration start to be more keenly felt.

We would also flag that the upcoming Q1 GDP release may be as weak as -2%, largely as a function of swollen gold imports distorting the data series. That said, this nuance may be lost on the public at large, and we see Trump needing to work hard to defend his plans in the days ahead.

As much as he may want to deflect the blame onto the Fed or others, it may seem reasonable that the media will be quick to highlight that the buck stops with the President himself. That being the case, it strikes us that economic developments and financial market reactions will be the forces that constrain Trump's policy actions going forwards and will effectively help bring an erratic and errant President more to heel.