The current US administration is tearing down previously supporting pillars of the economic system and prosperity. Stock markets are currently concentrating more on the positive news. However, the current measures create an environment that increases risks for capital markets in the long term.
The new US administration has only completed 15 percent of its term in office, but already the economic and foreign policy of the USA is more reminiscent of the world power behaviour of the British crown in the 19th century than of the period after the Second World War, in which the USA built an economic system and a new world order to prevent a repetition of the disastrous aberrations of the 19th and early 20th centuries.
Central wisdom of the post-war period that Washington is currently questioning: international cooperation and raising comparative strengths are beneficial for economic growth in all countries, tariffs prevent the efficient allocation of production factors and therefore have an inflationary effect, an independent central bank that keeps inflation expectations in check is a valuable asset and should therefore be treated with respect, the US dollar has to earn its role as the world’s reserve currency again and again, international cooperation is important.
Many of these findings, confirmed by the past economic crises, have been ignored by the US in the last six months. The new boss in the White House thinks little of international cooperation: He announces – and if someone dares to contradict, he is showered with additional threats. Tariffs have been imposed, and the current ones bring the average U.S. tariff rate to regions not seen since the 1930s after the Great Depression. Jerome Powell, the steadfast head of the FED, is being dismantled by Trump and his comrades-in-arms in public wherever possible. Members of the FED board who do not share his opinion are also in the crosshairs. The US dollar is to be devalued, according to the president’s economic team. But anyone who dares to question its uniqueness as a reserve currency and thus the financing of the “twin deficit” of the USA is threatened with draconian trade sanctions.
However, the capital markets have so far seemed rather unmoved. After a brief slump at the beginning of April, the stock markets in particular showed a positive performance. Why is this the case and can it stay that way in the long term?
The answer must start with the basis, which applies equally to political factors, wars and crises: capital markets have a single task and that is to determine the prices of different assets, they do not perform any moral or ideological function. So markets ask the question, which policies of the new administration have what implications for the price of which securities? Here it can be shown that there is a combination of factors that are little discussed in the public perception, but are currently having a positive effect. However, the negative factors are evident and are even further nourished by an erratic policy of the administration.
Let’s start with the positive measures, which are little reported but are very much registered by the capital markets. It is about the great and, in my opinion, always underestimated effect of awakening the “animal spirits”, of deregulation, of encouraging entrepreneurial activity. Even in Donald Trump’s first term in office, it became clear that such positive measures on the economy are underestimated.
In addition, there are “technical” effects, also as a result of tactical decisions, which are currently having a positive effect on the markets, but also on the economic picture. The introduction of the tariffs has been delayed several times. This had economic and sentiment effects. Economically, there were initially growth-enhancing effects and a postponement of price effects. First, purchases of cheap products, i.e. without additional tariffs, were brought forward and inventories were increased in the first quarter, then the opposite effect was reduced in the second quarter because tariffs were temporarily suspended. There were few price increases because the higher reciprocal tariffs were suspended for 90 days for most countries shortly after the so-called “Liberation Day” and “only” the basic tariff of ten percent applied. This was followed by a further postponement until the beginning of August. Companies are likely to have waited for the final level of tariffs to raise prices.
But even more important were the mood effects. When the US administration announced the first tariff break, the markets interpreted a “Trump put”, i.e. if the markets were too shocked by policy measures, the administration
, enriched with many billionaires and former capital market professionals, would react and give the markets what they needed.
Brave New World?
Is the US administration now rewriting economic history or will the downsides of this policy not be hidden in the longer term and have a negative impact on the economy and markets?
Let’s start with the tariffs. Now the president had even de facto called for the dismissal of one of Wall Street’s most renowned economists via Truth Social, because he had dared to claim that tariffs would have an inflationary effect, and Stephen Miran, who was nominated as a temporary replacement for the resigned Fed board member Adriana Kugler, also doubted this.
Now the economist could refer to the literature, but that would lead too far. To illustrate the argument, let’s make it very easy for ourselves. Let’s take as an example a European car manufacturer that produces a car worth 40,000 US dollars. If he exports it to the USA, he will soon have to pay a 15 percent tariff, i.e. 6,000 US dollars to the American state. Now there are three ways in which he can absorb this inch:
First, he can immediately produce 15 percent cheaper through technical progress or other cost-cutting measures and is satisfied with the previous profit margin. However, productivity increases of 15 percent in one year are rather unlikely. Second, he can just leave the prices unchanged, then the $6,000 will be at the expense of his profits, and since a few companies have a margin of 15 percent, he may even lose money. Or he can add a price premium of 6,000 US dollars to the price of the car, thus providing a massive inflationary impulse. In reality, it will be a combination of all these factors, but even if the price of the car is only increased by $2,000 to $3,000, it is inflationary in the United States. This applies to my small example, but it also applies to the economy as a whole. Whether this inflationary impulse is immediate, delayed or in several steps is irrelevant, inflationary effects are assumed in any case.
Thus, despite all the excuses, the tariffs in the USA will act like a consumption tax and are therefore inflationary. This can drag on for many months, but it would be reckless to assume that there is no impetus here.
As far as growth is concerned, uncertainty is slowing down investment and trade. It is only since the beginning of August that most countries have known the “final” tariff rate for them, although one must be careful with this statement given the erratic nature of the current executive branch in the USA. The fact that some of the trade uncertainty is now resolving is positive, but in view of the frequent course corrections of the US administration, this is not something that corporate leaders can build on in the long term, especially since even more sector-specific tariffs are threatened. The economic opening of the world brought prosperity benefits to all involved, including the USA, because everyone benefited from the international division of labour. This certainty is not only shaken, but also the fragmentation of the global economy that has already been initiated is additionally nourished. Relatively speaking, lower growth and lower productivity are not positive factors for equity markets.
Then the scramble for the independence of the FED. It is not an American phenomenon that, in times of sharply growing interest burdens for the overall budget, a monetary policy oriented towards stability principles is challenged. Fed Chairman Powell, but also other Fed governors who, based on their assessment of the economic situation, oppose Trump’s desire for very strong, rapid interest rate cuts, are now under pressure. Markets initially find the prospects for fast, lower, short-term interest rates not bad in themselves. In the medium and longer term, however, it is much more important whether inflation expectations remain anchored at a low level.
One paradox is that as long as Powell navigates the Fed, he will also have inflation expectations under control, despite all the public hostility of the current administration. But to believe that you can damage the institution at will, that you can treat or even select members of the Fed Board as you please, and then get the same confidence in the central bank on the markets as before, I am convinced that will turn out to be a mistake. Just think of how a few years ago Turkish President Erdogan’s “economic theory” that low interest rates would be needed for low inflation was faced. “Un-anchoring” inflation expectations have never been a positive factor, neither for bond nor for equity markets.
What remains is the already mentioned, recently highly traded argument of the “Trump put” on the markets. Finally, as mentioned, the president is also surrounded by billionaires, some of whom have made their fortunes in the financial markets – free lunch and quite a few in the market are on this trip. I can’t share that.
Technically, the American president still has 16 months before he could lose the majority, at least in one of the two houses of Congress, in the midterms and the current virtually uncontrolled approach could be curtailed – he cannot act like Alan Greenspan, who established the “Fed put” in a 19-year term.
What does this mean for the markets?
First, the economic decisions of the current US administration have become incalculable. What is certain is that they do not value the economic well-being of other nations and that weakness in negotiations is even “rewarded” with additional pressure – a lesson that Europe in particular has yet to learn.
This means that US assets are currently doing better than others, that Europe has been passed down the feed chain by the EU’s cave-in to trade negotiations, and that the fragmentation of the global economy will continue, as India, China or Brazil do not seem willing to back down as much as the Europeans have done.
Bond markets as a whole are facing a challenging time. In the USA, the approaches to government savings have practically come to a standstill. The two leading figures have drawn the conclusion: Elon Musk is taking care of his companies again, Vivek Ramaswamy now prefers to become a senator for Ohio. Tariffs as a revenue generation tool are one way to counter budget deficits, financial repression, for example the pressure on the FED to cut interest rates quickly, is the other way to make the debt burden bearable. In Europe, too, there are no attempts to catch the deficits: commitments to spend up to five percent of GDP on defense in the longer term and announced infrastructure investments signal that the issue volume of government bonds should increase here as well as worldwide. A further steepening of the yield curves in most Western industrialized countries is likely to be the consequence of higher deficits and the undermining of the standing of central banks.
For the stock markets, the long-term rule should be: the replacement of the “rule of law” with the law of the strongest may favor some companies, but on average of all companies representing the market, I predict, all will fare worse than in a world oriented towards global efficiency. In addition, the search for income continues. The fact that even corporate profits cannot be certain is shown by the “deal” that the U.S. Ad Department has made with NVIDIA and AMD, which had to “voluntarily” commit to paying 15 percent of the proceeds from these sales to the U.S. government in order to approve certain chip sales to China.
The difficulty for the investor is that there is no short-term trigger as to when the market will react to these political earthquakes. The wrong long-term decisions do not necessarily have to be reflected in the short-term movements, especially since, as already mentioned, some things also have a positive effect in the short term. In addition, the benchmarking of the industry punishes anyone who prices in long-term trends too early. But I am convinced that a party cannot last forever if the supports of the ballroom are removed.
In addition, there is the chaotic situation in geopolitics, like the Orwellian linguistic acrobatics. Employees of an administration that has just bombed Iran and is negotiating Ukraine’s territorial cession with Russia without Ukraine proclaim the president as a candidate for the Nobel Peace Prize (and after Peter Navarro, he also deserves the Nobel Prize in Economics).
When dominance and loss of reality are paired, and this in the most important country in the democratic world, there is much to be said for questioning one’s own risk tolerance and, in case of doubt, if hedging seems acceptable in price, to use part of the expected total return for the expenses necessary for hedging.
In the current world, there are no guarantees that the classic correlations, which have grown on the basis of the classic behavior of the actors (cooperation, independent central bank, etc.), will continue to apply. In my opinion, capital markets are currently in a dangerous trivialization of the current situation. To think that if you close your eyes to the dangerous situation long enough, the damage can never occur, seems to me wishful thinking and not prudent investment policy.
