Trump Creates a Secure Refuge for Financial Markets
The stock market seems unfazed by Trump's tariff maneuvers, but the bond market tells a different story. The faith of investors in the once-sacred debt titles has experienced a severe blow, prompting them to explore different financial avenues.
When a nation's finance minister declares the safety of its debts, it's usually a red flag. Often, such proclamations are mere attempts to stave off a looming default. Hence, it's no surprise that markets quaked when US Treasury Secretary, Steven Mnuchin, stressed that the US would "never default." The US, after all, holds the title of the world's most heavily indebted country, with $28 trillion of Treasury bonds in debt service.
While Mnuchin may have the audacity to make such statements, can he guarantee them? The US's debt level is unmatched by any other nation. However, it managed to sustain such a deficit due to investor trust. The US was seen as a "safe haven," a fortress where capital could find refuge.
Trump, with his unorthodox economic policies and trade wars, has eroded this status. The director of LBBW's economics department, Jens Kramer, former rating agency S&P employee during its 2011 downgrade of the US to "AAA," dubs this financial landscape as mined safe haven.
The Dance of Yields and Dollars
The signs of waning trust are evident as US bond yields and the dollar have decoupled. Historically, both have moved in sync, with the dollar's strength mirroring the strength of the US economy. However, since mid-March, this relationship has fractured, with the dollar devaluing by 4.7% while the yield on 10-year US Treasury bonds has risen from 4.16% to 4.42%.
Higher yields are typically a sign of a robust economy, attractive for capital inflows to the US. But these rising yields, cemented by fiscal concerns and political uncertainty, could weaken the dollar simultaneously. This pattern, often seen in emerging markets, signals a decrease in creditor trust toward America's debt mountain.
Moody's downgrading the US's credit rating from AAA to AA1 is but one indication of this. Credit Default Swaps (CDS), an insurance against debtor default, have now reached levels akin to Greece and Italy. Struggles in recent US government bond auctions further hint at the lack of investor confidence in the American debt.
Losing Foothold in Finances
Investors are already positioning themselves for a post-dollar world. Even if Trump's intention is to weaken the dollar to cheapen exports, a structural loss of trust in the dollar undermines the US's position as the world's reserve currency. Losing this status would rob Trump of significant bargaining power in negotiations—something he, self-proclaimed "deal maker," would likely avoid.
While shifts in the leading currency may take time and may have already been in motion before Trump, experts see Trump as the catalyst. Goldman Sachs asserts that a fundamental shift in the valuation of the USA may have occurred, leaving investors to seek alternative investments. They recommend building positions in euros, yen, and francs and tapping into gold as an asset class.
In essence, the long-term beneficiaries of Trump's policies lie in Frankfurt, Tokyo, and Zurich. As investors scramble for safety amid the eroded trust in the US bond market, alternative strategies, such as diversifying portfolios, investing in precious metals, and choosing short-term instruments, are emerging as wise moves for weathering the storm.
The US Treasury Secretary's reassurances about the nation's debt may not be enough to sway investors, as they are increasingly looking towards other financial avenues for security, including community and business policies that could potentially offer a return on investing. In light of the eroded trust in the US Treasury bonds and the decoupling of bond yields and the dollar, alternative investments, such as precious metals and foreign currencies, are being considered as a strategy for weathering the storm.
