A Little Bit Yippy

On “Liberation Day,” America sharply raised the price of participating in the US‑centric international trade and financial system.

Until now, this US‑led system had promoted a relatively free flow of goods and capital across borders despite an uneven playing field. Businesses sought the most efficient means of production, while savers pursued the best returns on capital. Flows were netted through the US dollar, against which most other currencies are quoted, placing the greenback at the centre of the system.

President Trump sees the US trade deficit as an outflow of wealth. But most dollars that “leave” the United States through trade are recycled back into US securities. Before the Lehman crisis, this recycling was done mainly by foreign central banks with pegged currencies, such as China’s. Recently, private investors have taken the lead, attracted by America's remarkable post‑COVID resurgence.

In other words, America’s trade deficit and the liquidity that drives its financial markets are linked. Causality can be debated and probably runs both ways, but the key takeaway is as follows: cutting the deficit means choking off the liquidity that makes America’s financial markets unique.

According to data from the US Treasury, foreign private investors purchased half a trillion US dollars’ worth of US Treasuries in 2024, or about 40% of total net issuance. They also purchased US$430 billion of American stocks. We have no current data on how much they might have sold since “Liberation Day,” but the liquidation of American securities, including US Treasuries, was substantial. US stocks broadly underperformed global indices, and the treasury market came unstuck. The fact that foreign investors were fleeing is also evident in the US dollar’s broad‑based decline.

While President Trump seemed willing to accept lower stock prices, this week’s rout in the treasury market precipitated an about‑face. Interest rates on US government debt had risen across the curve, with the long end leading the way higher and exhibiting unusually high volatility. At one point, the 10‑year bond yield broke above 4.50%, and 30‑year yields revisited cycle highs around 5.00%.

President Trump announced a 90‑day pause during which the reciprocal tariffs are 10% for all countries that faced these tariffs, except for China, whose tariff rate stands at 145% at the time of writing.

We think there are three key takeaways here for investors.

1.    The bond market once again played its role in regulating the government. It revealed America’s vulnerability as a debtor nation.

2.     A 90‑day pause is a 90‑day pause. Significant business uncertainty is likely to persist, especially since the outcome of bilateral negotiations is unclear, and even the lower tariff rate is a significant stagflationary shock to the US economy. Forward‑looking market indicators such as the ratio of copper to gold prices continue to signal a recession even after the 90‑day reprieve was announced.

3.    China looks isolated for now, but a cornered tiger is dangerous. If China is completely shut out of US markets, President Xi may think he has little left to lose. He may order sales of US Treasuries (China owns US$760 billion) or even escalate the sabre‑rattling around Taiwan. On the other hand, President Trump may yet offer an olive branch to China.

In short, we doubt President Trump’s 90‑day pause will put the recession genie back in the bottle or rebuild lost trust overnight. Markets may stay “a little bit yippy” for a while yet.