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This was the week when the tariff tantrum morphed into something much more serious. Analysts and investors are now openly questioning whether the US can keep its position at the apex of global finance.
Alphaville has raided our inbox for some of the more eye-catching bits that have come out this afternoon. As Barclays’ Ajay Rajadhyaksha title notes: “This is not normal.” Quite. The emphases in bold below are Alphaville’s.
Whether you think it’s mostly due to basis trades and swap bets unravelling, worries about America’s fiscal trajectory or overseas central banks quietly ditching Treasuries, the end result is clear, according Rajadhyaksha: “Bond markets are in trouble.”
And it comes at an awkward time:
For nigh on 20 years, the US has benefited from almost relentless flows into USD financial assets. Bonds, equities, credit, the currency — all have benefited. Coming into 2025, the US was about 25% of world GDP and 65% of global equity market capitalization. Perhaps we were primed for some give-back, anyway, in US financial assets. And a bunch of things have changed elsewhere. China has made impressive strides on the technology front (not just Deepseek but also break-throughs by Huawei and BYD, as just two more examples) and embraced its private tech sector. Europe has finally bought into the idea of large fiscal stimulus. At least from a narrative standpoint, there seem to be some alternatives for international investors heavily over-exposed to the US.
US financial markets remain the largest and deepest and most liquid in the world. But for those already worried about too much exposure to the US, alternatives are finally popping up. And after the policy uncertainty of the past few months, international clients now ask us questions such as, will the US impose a Tobin tax? Are capital controls a real risk for foreign investors? Would they be better off in Bunds than in Treasuries to express a duration view, because of ‘country’ risk? We think these concerns are very overstated. But the very fact that they are even being asked — and the price action of the past five days — suggests that there may be a (slow motion) move in capital away from US assets. If that is actually occurring, it couldn’t have come at a more inopportune time.
Investors raising questions that would not long ago have been preposterous is also a theme in the Friday report from Evercore ISI’s Sarah Bianchi.
She reckons that the disruption and uncertainty unleashed by the Trump administration in its first two months is so extreme that even a full rollback of its trade policies probably wouldn’t matter.:
Tariff policy is the proximate cause, but the fact that the U.S. is now upending the global trading system it built over decades raises questions about long-held policy U.S. assumptions — some of which the Administration itself has questioned.
One of those assumptions is Fed independence: The Supreme Court is set to hear a case on Trump’s ability to fire independent agency heads that could give him the power to fire Fed governors at will.
Another is the dollar’s reserve status: recent remarks by the CEA Chairman focused on the disadvantages of the dollar’s reserve status, suggesting the Administration may not be so focused on preserving it. This is not a theory that has much traction internally, but may be on the minds of some in an era of disruption.
All these issues are coming at a time when fiscal deficits are highly elevated. While the market has long been tolerant of the U.S. government’s fiscal trajectory, this week’s budget deal underscores that there is no real path for these deficits to go anywhere but up.
On trade, tariff rates on average are just as elevated as they were last week with just a radically different mix. Trump could move to cut a deal with Japan or Korea to attempt to give some clarity on the ex-China trading partners, although we question whether that would be sufficient. More dramatically Trump could try and find a quicker off ramp on China — a step that we think would require the Trump team to feel peak duress to consider.
Our real concern is that while Trump may be able to cut a few tariff deals, when the issue is a broader loss of confidence in the United States, even a much fuller retreat on trade might not work.
Jonas Golterman at Capital Economics also worries that (to borrow our colleague Katie Martin’s expression) the shit cannot be shoved back into the donkey. The title of his Friday note is: “How to lose a safe haven status in 10 days”:
After another tumultuous week across financial markets, the dollar is on track for one of its worst weeks on record. At this point, the main question for the dollar is no longer what the direct effects of President Trump’s tariffs (many of which were paused on Wednesday) will end up being.
Rather, the key questions are around the indirect damage done through generating extreme uncertainty around the policy and economic outlook, the ongoing dislocations in the US Treasury market and, ultimately, undermining confidence in US institutions and asset markets.
It is too soon to say what the longer-term effects of the past ten days’ turmoil will be, and there is still time for damage limitation by policymakers. But, in our view, it is no longer hyperbole to say that the dollar’s reserve status and broader dominant role is at least somewhat in question, even if the inertia and network effects that have kept the dollar on top for decades are not going away any time soon and our base case is that it will recover to some degree.
Freya Beamish at TS Lombard points out that worries about the “dollar standard” are nothing new. People have been predicting its demise ever since Richard Nixon ended is convertibility to gold. And time and time again it has instead strengthened at times of strife.
This has been upended in recent days, but to truly break the dollar system two things are required, Beamish argues:
1) To seriously tamper with the Fed
2) And/or directly to hinder capital inflows through some form of Mar-a-Lago policy (we hesitate to use the word accord here).
The first of those conditions is now being met and rhetoric over the past few weeks increased our conviction that the second is being seriously considered. We continue to think that China and the US reach a deal bringing down tariffs to around 30%. But the risk of escalation through RMB depreciation is significant and that brings US capital controls into play.
Investors might be able to make a fast buck if announcements are reversed or if key checks and balances kick in but for all but the most nimble and high risk investors, we judge that the Trump administration is now half way across the Rubicon. If Trump makes it all the way across, utter chaos will ensue. There is no market that is deep enough to accept the capital currently held in the USD financial system. If he stops and wades back, the dollar might recover. But that will be a massive selling opportunity.
George Saravelos at Deutsche Bank reckons that the world is already starting a long process of “de-dollarisation”, and warns that the consequences for the US and the rest of the world are seismic.
At the very least, it suggests that the US dollar is going to weaken a LOT from here, according to Saravelos:
US fiscal space is rapidly diminishing. We have long argued that a country’s fiscal space is determined by its external balance rather than its debt-to-GDP ratio: what matters for debt sustainability is a country’s reliance on foreign financing, reflected in the tight correlation between global bond yields and current account deficits. The US has been the exception to this rule, able to secure funding for its extreme twin deficits thanks to the dollar’s exceptional status. With this now changing, the steady state level of sustainable US fiscal deficits is moving lower. This reduces the flexibility of the US administration in pursuing expansionary fiscal policy to support growth, much in the same way the UK and France have faced similar constraints. US policy flexibility is becoming a lot more constrained going forward; this by extension implies greater headwinds to the growth outlook.
Foreign policy will now influence US financial markets. The challenge for the USD and the US bond market is not just de-dollarization. It is that the twin deficit position requires ongoing funding from foreigners to be sustained. By extension, foreign investor risk sentiment becomes all the more important in ensuring bond and currency market stability. It is an oft-repeated phrase that a twin deficit country is dependent on the “kindness of strangers“. This now applies to the US, but by extension it will make the stability of US markets all the more dependent on non-confrontational foreign and economic policy to ensure their funding. We argued more than a month ago that references to the ownership of Greenland, for example, where contributing to an undermining of USD stability. We suspect the US administration will have to adopt a more conciliatory stance in international relations to maintain stability in the bond market going forward.
Ultimately, it is all about valuations. A number of press reports have suggested that recent price action in the US resembles EM-like characteristics. This is true to the extent that the bond and currency markets are declining at the same time. But there is one key difference that will ultimately work to the US advantage: the economy does not have any large foreign currency liabilities that would lead to explosive debt dynamics. In contrast, currency and bond market weakness should ultimately lead to cheaper valuations and a new equilibrium of asset pricing that becomes attractive for foreigners to invest. The dollar’s biggest challenge at the moment is it’s starting point of high valuations, high foreign asset allocations and a confrontational foreign policy approach. This on balance significantly raises the valuation adjustments that need to take place to make US assets attractive again.
Have a great weekend everyone!
