Chaotic policies, chaotic markets
Policy made on the hoof. Stocks, bonds, currencies in flux. Gold firm.
Markets continue to gyrate as they absorb the impact of Trump's "liberation day" tariff sledgehammer. Policy is evolving on the hoof. We remain a long way from any sense that the dust has settled.
In fact, this could be just the start. That's assuming that the effects cause higher inflation (especially in the US), result in economic recessions (whether inside or outside the US), and create financial implosions in some of the leveraged dark corners of financial markets (more on that below).
Here's an update on the main policy developments since my summary last week (see "Liberation Day" sparks global market chaos):
China imposed reciprocal tariffs of 34% on US goods imports
The US increased its tariff rate on Chinese imports to 84%
China imposed reciprocal tariffs of 84% on US goods imports
The US increased its tariff rate on Chinese imports to 104%
President Trump announced a 90-day pause on rates above 10% for every country apart from China, as negotiations continue. But everyone still gets 10% straight away
The US increased its tariff rate on Chinese imports to 125%
The European Union announced 25% import tariffs on a range of US goods, including orange juice, soybeans, steel and yachts. But the US has yet to announce further escalation (at the time of writing…
Mexico and Canada will now be included in the lowest 10% tariff band (although presumably all car imports will still get a 25% tariff)
Trump said that a "major" tariff will now be levied on imports of pharmaceuticals, which were previously exempt. Details are yet to be announced.
The developments continue to come thick and fast...
If you know anything about China, then it's certainly no surprise that its government has responded in this way. And by the time you read this it's possible that the country will have hiked import tariffs on US goods even further.
One obvious sector that's likely to suffer is US farming, as Chinese importers seek to purchase agricultural commodities elsewhere. Meanwhile, potential beneficiaries include alternative major agricultural exporters, such as Brazil and Argentina.
Both the US and China will suffer in this escalating trade war. The world's two biggest economies are duking it out, and neither will want to lose face and appear to back down.
At the National Republican Congressional Committee dinner on Tuesday, Trump said the following:
I'm telling you, these countries are calling us up, kissing my ass. They are! They are dying to make a deal. "Please, please sir, make a deal. I'll do anything. I'll do anything sir!".
One thing that I can guarantee is that, for good or ill, there will be no ass kissing emanating from Beijing. The only way to resolve the situation will be a negotiation where both sides treat each other as equals. We seem a very long way from that.
That said, Trump made this claim on Wednesday:
China wants to make a deal. They just don't know quite how to go about it.
Maybe, maybe not. But, in my experience, the Chinese know very well how to negotiate and make deals.
(I lived in Hong Kong for several years, and negotiated multiple joint ventures in mainland China for the investment bank where I worked at the time.)
Meanwhile, the deferred clarification about Mexico and Canada, along with the announcement about pharmaceuticals, show that these policies are being made up on the hoof, in a pretty chaotic manner. Why wasn't pharma included last week? Why is it suddenly a good idea to make US healthcare (even) more expensive?
US stocks continued sliding through Friday, Monday and Tuesday. They also opened down on Wednesday, before leaping 8-10%ish after Trump's mid-session announcement of the 90-day so-called "pause" (but still with tariffs at 10% for everyone except China).
However, it remains to be seen whether that relief rally will be justified in the end. Many investors may take the opportunity to sell on this bounce, or later regret that they didn't. Not least since the US stock market remains richly priced by just about any measure, and uncertainty levels - for policy, for the economy - are now high.
What's more, anyone betting on further falls will have been caught on the hop. Such as retail traders using leveraged short ETFs. And anyone that sold stocks during the previous days will have missed out on the sudden bounce.
There's a lot of speculation that the tariff "pause" was because the US government got spooked by market developments. Naturally, this has been denied. But it seems likely.
Specifically, it could be the US treasury bond market that's on people's minds, and not so much the stock market. After the initial knee-jerk, "flight-to-safety" reaction on Thursday and Friday (treasury yields down, prices up), bonds were thrown aggressively into reverse gear (yields up, prices down).
There's been a lot of talk that this was caused by highly leveraged hedge funds having to unwind positions, and thus dump treasuries.
There’s something that are known as "basis trades", where hedgies attempt to arbitrage tiny price differences between treasury bonds and futures contracts. Because the price discrepancies are tiny, these trades only pay out enough if they're highly leveraged bets, using perhaps 50 or even 100 times the actual underlying invested capital.
Similar types of leveraged bond market arbitrage trades are known as "off-the-run trades" and "swap spread trades". These sorts of thing are pretty technical, so I won't explain them in full detail here.
All you need to know is that a lot of incredibly leveraged capital is riding on US treasury bonds. When those trades go against the hedge funds, and also when market volatility increases, the lenders - usually the "prime brokerage" desks of big investment banks - start calling in the loans.
This leads to forced selling, which can become self-reinforcing. The more that's sold, the more prices drop, the more that's lost, and the more that needs to be sold. This is what market crashes are often made of.
(For those interested in the nitty gritty of these trade strategies, FT Alphaville did a good summary that you can find here. That part of the FT is free, but you have to register.)
Meanwhile, bond markets in other countries are being hit too. Over-indebted developed countries (and quite a few less-developed ones) have dug themselves into a strategically weak position. They don't have the financial firepower to respond to difficult circumstances such as these, or worse.
To give one example, yields on 30-year UK gilts just hit their highest level since 1998.
There's also increased market chatter about the Fed and other central banks firing up their virtual printing presses again, and using quantitative easing (QE) to buy up government bonds, thus stabilising the bond markets.
To the extent that QE bond purchases are made from non-bank investors (a technical but important point), they result in the creation of new bank deposits. Thus they increase the money supply.
US import tariffs are already highly likely to prove inflationary for the US. As explained last week, prices of imported goods will obviously rise, along with prices of existing American goods (you can charge more when the competing products have higher prices), and the prices of any re-shored production in future, where goods are made more expensively than overseas.
But if a big slug of QE money is thrown into the mix as well, then it would add even more inflationary fuel to the fire. Given that such QE would be designed to suppress treasury yields, something else would have to give. That something else would most likely be the US dollar, sending it down against other currencies and probably gold (all other things being equal).
As we wait for things to unfold, a lot of non-US stocks have sold off around the world, even of companies where there's no obvious direct effect of the US tariff policies. Such as, say, domestic services businesses in the UK. As things settle down, there are likely to be some great buying opportunities.
That said, higher recession risk and higher bond yields will tend to suppress stock prices in general, along with panicky investors pulling out of index funds. But there are likely be offsetting factors in time, such as cheaper imported goods (inputs to manufacturing or finished products sold to consumers) from countries hit by US tariffs (due to a potential global supply glut), and reductions of central bank policy interest rates (lower inflation outside the US etc.).
One area where I believe investors should be very cautious is the banking sector, both inside and outside the US. Recessions usually result in a lot of bad debts. These developments could be the straw that breaks the refinancing camel's back, as debts become due.
In the middle of this, gold is holding up very well. It's an island of relative calm in the market storm. Silver much less so, since a much larger share of it is used in electronics and other industrial applications. Hence, when recession fears mount, it's typical to see weakness in the price of silver.
As the market chaos continues, it's important to remember that global trade has not suddenly come to a hard stop. It's just that there will be less sold to - and quite possibly bought from - the US in future.
In the meantime, investing in the US just got a lot riskier, whether that's stocks, bonds or the dollar. Government policy is being made on the hoof, and nobody knows what else may be sprung onto unsuspecting markets in future.
Whether or not the tariffs are good for America, in the end, is another matter entirely, either economically or otherwise. The unintended consequences, both at home and abroad, could easily outweigh any supposed benefits.
On which note, it's worth watching this thoughtful speech from the Prime Minister of Singapore. He makes a lot of valid points about potential adverse repercussions for the world, which are either unconsidered or ignored by the White House.
Please send comments or questions to the email shown below.
Until next time,
Rob Marstrand
email: ofwealth@substack.com
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