Summary
US policy uncertainty is driving market volatility and a reassessment of Treasuries as safe havens. While trust in US assets remains, challenges to the Fed may undermine investor confidence.
Trade war complicating the Fed’s job
Extreme policy uncertainty in the US is leading to sharp movements and increased volatility. Recent bond yield dynamics signal a shift from seeking safety in US assets to a reassessment of Treasuries and the USD as ultimate safe havens. While we think it is too early to question the trust in US assets, we also think any challenge to the Fed’s independence and so much policy uncertainty could undermine investor confidence.
Tilt to Europe duration
We are witnessing higher term premium in the US along with higher inflation expectations owing to uncertainty around import tariffs. While the Fed will be forced to deal with these inflationary pressures in the near term, inflation is less of a concern for the ECB. This could create some policy divergences between the two global central banks, leading us to downgrade our terminal rate expectations for the ECB.
Rotation opportunities amid a sell-off
The rotation that started at the end of last year is still continuing and has been fastened by the trade war. As a result, US equities have been the most affected, leading to a derating in valuation multiples. Despite that, valuations remain expensive and other regions are relatively more appealing. In Europe, the key factor to monitor is the extent to which fiscal stimulus and infrastructure spending could offset the impact from tariffs
EM Divergences in the tariff disruption
While emerging markets are sensitive to developments in global trade, policies of the US administration and geopolitical developments, some regions/countries seem to be more affected by US tariffs than others. At the same time, resilient domestic economic growth and less correlated economic cycle (from international trade) in select regions mean there are ample opportunities to diversify and generate income over the long term.
US exceptionalism at risk: stay flexible
Liberation Day’ marked a massive US policy shift towards a more chaotic, transactional approach. US growth slowdown would depend on the duration of these tariffs and retaliation from trading partners. The damage to investor and consumer confidence has started already and markets are challenging US exceptionalism. But macro, credit and liquidity conditions are reasonable. In this environment, we explore all levers available, including EM bonds, and believe the supremacy of the dollar in FX is at risk. At the same time, we think investors should keep portfolio safeguards, such as gold, intact.
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