The tide is turning against the dollar and US bonds. — Reuters
ANOTHER tariff climb down from the Trump administration sparked a relief rally in world stocks and bonds on Monday, but smoldering growth fears and deep-rooted doubts over the wisdom and execution of US trade policy limited the euphoria.
Zoom out and the world continues to reassess its long-held faith in the dollar and US Treasuries, the fates of which increasingly appear to be in the hands of foreign private sector investors.
There’s no doubt investors welcomed the news late last Friday that smartphones, computers and other electronics imported mainly from China will be exempt from the steepest US tariffs, but Wall Street’s fizzle as Monday’s trading progressed was telling.
The main US indices posted considerably smaller gains than their main Asian and European counterparts earlier in the global day, and the steep fall in short-dated Treasury yields reflected investors’ underlying gloomy view of the United States economy.
Federal Reserve (Fed) governor Christopher Waller said the economic shock from Trump’s tariff policies could necessitate steeper-than-expected rate cuts even if inflation remains high.
The New York Fed’s latest consumer survey showed one-year inflation expectations jumped last month to the highest in two and a half years, while unemployment fears were the highest since the pandemic.
All in all, and even accounting for the latest tariff exemption, the shadow of ‘stagflation’ is looming large over the United States economy. It’s the worst of both worlds for policymakers and investors.
The performance of tech shares on Monday was revealing. Chinese tech stocks listed in Hong Kong rose more than 2% – their fifth daily rise in a row – and European tech stocks climbed 2.6%.
But despite a strong open and shares in Apple surging as much as 7.5% at the open, the wind came out of US tech’s sails and the sector ended the day only 0.6% higher.
China said it is evaluating the impact of the exemptions, and if Beijing confirms its initial cautious welcome, global trade tensions may ease for a while. Or at least stop intensifying.
This could allow markets to take their cue from other drivers, such as the first quarter US earnings season that is now picking up steam.
Big banks like JP Morgan and Goldman Sachs have reported strong results, although the trading and economic environment in the January to March period will bear no resemblance to the following quarters.
But Trump himself has signalled investors should not get too excited, telling reporters on last Sunday that although there will be flexibility with some tech companies, he plans to announce tariff rates on imported semiconductors over the next week.
Private investors key
Foreign private sector holds key to US Treasuries amid the cacophony of chaos in financial markets created by the Trump administration’s tariffs, the loudest – and most alarming – signal is surely the simultaneous slump in the dollar and US Treasury bonds.
It’s too early to say whether this is the beginning of a more prolonged trend.
But it is a warning that faith in US assets – and indeed, the global financial system of the past half-century shaped in America’s image – cannot be taken for granted.
It’s never advisable to let long-term forecasts be swayed by short-term price moves but last week was potentially pivotal, both for the dollar and Treasuries.
Whether it turns out that way will be determined to a large extent by overseas private sector investors, who have emerged as significant marginal buyers even as foreign official sector holdings of Treasuries barely moved over the past decade.
Private sector investors have greatly increased their holdings of Treasuries and, by doing so largely on an unhedged basis, also greatly increased their exposure to the dollar.
If a global crisis of confidence in the United States does snowball, they will be more likely to head for the exits before their more staid, conservative central bank counterparts.
Foreigners held US$8.5 trillion of Treasuries in January, US Treasury figures show – central banks with US$3.8 trillion and the private sector with US$4.7 trillion.
Five years ago central bank holdings were US$4.2 trillion and private sector investors held US$2.9 trillion, and a decade ago official holdings were more than twice as large as the private sector’s stash of US$2 trillion.
Japanese institutions and households are among the largest holders of Treasuries on the planet, and if they reflect private sector thinking in other countries, investors and policymakers should brace for further market upheaval.
According to Bank of America, Japanese private investors sold US$17.5bil in long-term Treasuries in the week through April 4, the largest amount of foreign bond sales since before the United States election in November.
Dollar tide turning
Eroding confidence in the dollar and Treasuries, the two pillars of the global financial system would of course have serious long-term consequences for the world.
The more immediate fallout for investors has been no less dramatic.
Last week the 30-year US Treasury yield rose 48.5 basis points. It was the biggest weekly rise since June 1982. The benchmark 10-year yield’s 50-basis point surge was its steepest weekly rise since November 2001.
At the same time, the dollar fell nearly 3% against a basket of major currencies. Excluding the global financial crisis and the Covid-19 pandemic, this has only happened five times in the past 30 years, and one of them was last month.
Analysts at Goldman Sachs note that last week also marked only the fifth week since 1980 where the euro, or a pre-single currency weighted equivalent, rose 2% and the S&P 500 fell 2%.
In other words, a significant slump on Wall Street is rarely accompanied by an equally steep decline in the dollar.
Goldman’s foreign exchange strategy team last week flipped their dollar call to a bearish view, arguing that the recent breakdown in “usual” correlations is a clear sign that “markets are concerned about what recent policy actions imply about US governance and institutional credibility.”
They were joined on Monday by strategists at HSBC, who note that “as long as US economic policy uncertainty is elevated, it will be difficult for the dollar to recover versus other core currencies.”
Also on Monday, Barclays’ foreign exchange team published a note, “The end of the dollar as we know it?”, in which they observe that the euro’s spike to US$1.1480 from US$1.0950 last week was a move rarely seen over a six-month time frame never mind two days.
The tide is turning against the dollar and US bonds, certainly at the long end of the curve, and the power to direct the flow is now increasingly in private, not official sector hands. — Reuters
Jamie McGeeveris a columnist for Reuters. The views expressed here are the writer’s own
