Trade Wars & Capital Wars
US Bonds, FX, and Equities
As many strategists have observed, accelerating US twin deficits have featured a recycling of trade imbalances into US assets. The US in effect borrows from the rest of the world to pull forward consumption and government spending, funding these expenditures by selling to foreigners its overvalued US assets (both stocks and bonds). As these imbalances are shoved into a chaotic unwind by the Trump administration, the Fed is paralyzed by “uncertainty” and told us this week that they want to wait before determining whether weakening growth will outweigh any inflationary impacts from tariffs.
Many still see coming price increases as a one-off before the inevitable “crowding out” of consumers’ wallets — if tariffs are a tax, then it makes sense that such a consumption tax would crowd out a consumer’s discretionary expenditure no differently than rising gasoline and food prices, particularly when it comes to services. If you’re paying more for sneakers and clothes, maybe you go out to dinner less. This makes sense, but as I have gone to lengths to nuance, it skirts the possibility of creating inflationary expectations where consumers and corporates expect higher prices in the future, and therefore bum-rush spending (among consumers) while holding off on orders and hoarding inventory to make sales at future higher prices (among companies). Covid? One off. Russia invasion? One off. Tariffs? One off. At some point a parade of one-offs become seen as a trend, and expectations are created. I raised this concern in the immediate aftermath of Liberation Day here.
In the month since Liberation Day, what have we begun to see?