Trump and Dump

Tariff turmoil…it’s been a wild ride this week!

Financial assets underwent some wild swings over the past week, as markets continued to reel from last week’s US tariff announcements. In the wake of a market slump, a subsequent decision to pause higher rate tariffs for 90 days has led to some investor relief.

However, China remains subject to penal duties, even as others are levied 10% tariffs. This is set to materially disrupt trade between the world’s two largest economies, and our sense is that there is little appetite to row back much, given a more strategic desire on the part of Washington to pull supply chains and businesses away from a country it views as a potentially hostile adversary.

As markets have come to understand that US trade policy represents a stagflationary, adverse supply shock, it was telling how an initial flight to quality, which helped bond yields to rally, moved into reverse, with it also becoming clear that there is little that central banks can do to support growth, if inflation is moving sharply in the opposite direction.

The rise in long dated bond yields risked destabilising markets further in something of a ‘Liz Truss’ style moment, and perhaps this was the pretext for Trump’s tariff delay. Spiking volatility had seen a widespread ‘stop-out’ of fund positioning as losses accumulated around global markets, with liquidity worse than at any point since the Covid shock in March 2020.

Looking forward from this point, it is hard to be too definitive, given how rapidly events have been changing. Yet we have consistently argued that tariffs would be applied and are here to stay, having thought that we would ultimately witness a 10% universal tariff on US imports legislated through Congress later this year.

We had looked for a bumpy period in the interim and this has certainly played out, though it strikes us that if the end point of a 10% tariff is coming more clearly into view, then we could be past the worst of the disruption at this point.

This has seen us lift credit hedges and extend risk in the wake of spread widening, though the current volatility backdrop has made us move with some degree of caution. Meanwhile, we have retained a cautious stance on duration and have been pushing back on rate cut expectations. At the same time, we feel that we have seen the end of US growth exceptionalism for the foreseeable future.

Consequently, we have been inclined to turn against the dollar and have continued to think that the yen looks well positioned to rally, as may currencies in countries with the ability to deploy fiscal easing in order to mitigate the trade shock.

We expect the Federal Reserve to maintain rates unchanged in the next few months. Lower oil prices may help to mitigate against inflation in the near term, though this won’t offset goods prices elsewhere. In addition to importers raising prices, the potential for supply chain disruption can lead to shortages and beget price rises elsewhere.

This may well feed into inflation expectations and lift wages, even against the backdrop of a softer labour market. In this case, we have thought that inflation-linked bonds may be attractive at this juncture, and we have found it anomalous to reflect how the past week has seen inflation breakeven rates actually move in reverse amidst the ongoing market upheaval on a global basis.

In Europe, we also look for the ECB to be cautious with respect to monetary policy. At a time when Germany is embarking upon an ambitious easing of fiscal policy and inflation risks sit on the upside, we sense that a number of ECB hawks will push back on delivering additional rate cuts in the coming months, having already lowered rates relatively close to where the governing council would see neutral interest rates sit.

By contrast, we continue to look at the Bank of England as more dovish than other central banks, given their adherence to model outputs, which will tell them that inflation appears set to slow, even when most analysts would expect it to rise. A UK rate cut in May is thus a possibility, even though we think this could be a policy error. We would also note that cutting rates when inflation is too high is only likely to add to upward pressure on long dated bond yields and cause curves to steepen.

Elsewhere in Japan, the BoJ will be cautious about signalling further rate hikes in the near term, though it was always likely to wait until July before considering another step on the path of policy normalisation. In this way, Ueda has time to wait for the moment.

However, policymakers in Tokyo are likely to be more unsettled at the lack of liquidity in the Japanese bond market and at the long end of the curve, a forced capitulation saw some huge moves up and down in yields, which won’t be helpful for domestic risk appetite. Arguably, policy officials at the BoJ could do more to ensure a smooth and orderly market and help support liquidity at times of market stress.

For a long time, yields in Japan have been anchored and this has seen liquidity drain away from the market as the BoJ itself was largely controlling prices. As it rightfully steps back, ensuring that liquidity improves will be important for Board members to encourage.

Reflecting on the week, we have expected the 10/30 curve to flatten as the BoJ’s purchases of 10-year bonds decreases, with Rinban operations being scaled back. However, long dated Japanese bonds have been adversely affected by the trend, which has impacted other long dated government bonds.

In other markets we are inclined to see curves as too flat and subject to steepening pressure, though in Japan (and also Australia) we feel curves are already too steep and more likely to flatten going forward.

We would also reflect that having been relatively prescient in our analysis with respect to tariff announcements in the run-up to Liberation Day, we have been caught out by the sense of surprise from others, which has triggered some much larger moves and higher volatility in certain assets than we would have anticipated.

This has also meant that we started lifting credit hedges earlier than we should have done, with the benefit of hindsight. However, we are happy to have extended credit risk on the view that markets have moved from a period of complacency in the run-up to April 2nd, towards an environment of hysteria in the days that followed.

Looking ahead

From this point, we would expect financial market volatility to abate for a period. In the coming 90 days, we expect negotiations to lead to many of the additional proposed tariffs ultimately being avoided.

We see US growth slowing to 1-1.5%, which is below trend, but only a modest increase in unemployment given a clampdown on immigration. PCE inflation could rise towards 4%, inferring a Fed on hold and suggesting that nominal GDP remains not dissimilar to the recent past but with an adverse mix of less growth and more inflation.

Consequently, it still seems like a stretch to turn bullish on US stocks here, though if recession is avoided as we may expect, we are inclined to see credit performing okay in the coming weeks, having re-priced wider since the start of the year.

We are also more inclined to be constructive on other global markets, as investors seek opportunities away from the US market and Mag 7. Valuations in Europe have long been depressed and so may entice buyers.

Certainly, it has been notable to witness how defence stocks in the regions have been bomb proof, relatively speaking, in recent days. Meanwhile, we observe that periods of volatility can be painful, especially if this causes position capitulation at distressed levels.

However, as volatility fades, valuations can correct and there are opportunities to add performance against such a backdrop in markets. For sure, Trump is changing the world as we know it. But at the same time, there is no need to throw the proverbial ‘baby out with the bath water’.

As for Trump himself, you wonder if he might quietly reflect that he would be better off focussing on his golf game rather than creating chaos on a global level, which will surely end up undermining the way in which the rest of the world views America, trusts America and deals with America for a generation to come.

MAGA supporters may argue that all will be well that ends well. Yet, for all the logic that may sit behind some of Trump’s policy initiatives, the delivery has been clumsy, amateurish, and at times, completely incompetent.

Unlike Liz Truss, Donald will remain as POTUS for longer than the life of a lettuce. Though one might just hope that the period of peak craziness may be behind us and, going forward, there may be more consideration and counsel put into the policy steps that are announced.

Certainly, after a week when it almost felt like the sky was falling in, it is nice to end on a more constructive note. Markets have been challenging, but these are the very times to look for opportunities and remain bold, without retreating and giving into fear.

However, for those that listened to Trump’s “this is a great time to buy” message on Wednesday morning, just hours before his tariff rollback announcement, it has been a great week. Indeed, one can’t help but wonder whether this could have been his plan all along in the mother of all market manipulations – like a reverse “Trump and dump”!