EU’s ‘new economies’ mustn’t be strongarmed by tariffs

Economic

Summary:

Central and eastern Europe hardly lack alternatives but co-operation requires compromise.

Laughter over tariffs set by US President Donald Trump on imports from various countries quickly turned to chills as stock markets plummeted. Then, once plans were paused after tanking financial markets, we all laughed again.

Yet somehow, in the glee over Trump’s apparent defeat, we failed to notice that we’ve accepted as a baseline for negotiations tariffs on our US exports that are roughly five times higher than those applied to the European Union and UK until April 2025.

Financial markets and fairness

The administration’s stance on international trade has long been driven by the belief that the US trade deficit results from unfair trade relationships. In order to curb a significant weakening of the US position in its critical rivalry with China, this leads to three core approaches to US import tariffs.

First, for Trump’s team, global trade isn’t governed by principles of fair, equal competition. The only way to measure this unfair competition is the outcome itself: the US trade deficit. The formula for calculating new ‘reciprocal’ tariffs doesn’t focus on tariffs for specific goods but on the overall trade balance between the US and its partners.

Second, US import tariffs have two main goals: weakening China in global competition and generating federal revenue to enable the elimination or significant reduction of corporate and individual income taxes, even capital gains taxes. Tariffs, therefore, cannot remain at current levels – they must increase.

Third, they were prepared for – and expected – radical changes to the US tax system and new tariffs to cause disruption and potential financial market shocks before delivering a manufacturing revival. Only the threat of collapsing government bond prices, signalling broader financial market trouble, might have prompted some reflection.

It’s also worth noting that Trump’s team often speaks of other measures beyond tariffs, such as taxes on incoming capital to reduce its attractiveness to the US. Less frequently, but still notably, they mention the possibility of restructuring US debt, likely targeting debt held by foreign owners.

In outlining the Trumpian worldview, it’s only fair to add a few factual notes. The loss of manufacturing jobs in the US stopped long ago. US manufacturing actually added jobs compared with the situation more than 10 years ago. Average wages in manufacturing have grown steadily at over 3% annually, with hourly wages now exceeding $35. The median real income has risen by about 23% since its 2012 low. That’s roughly 1% per year, not spectacular but hardly a collapse into poverty. As for growing inequality, data suggest it has largely stabilised for over a decade.

Europe’s role in America’s worldview

In discussions about Europe’s part to play for the US, their perspective and goals can’t be ignored. This defines the potential compromise the EU could achieve – ideally to our benefit – on tariffs and industrial policy.

Any compromise must include easing our non-tariff barriers. Changes to the General Data Protection Regulation framework, under discussion in the European Parliament in March 2025 – with talk of possibly abandoning it – could be a promising start.

Another demand from Trump’s negotiators will surely be limiting EU trade with China. It’s hard to imagine the US tolerating the EU becoming a ‘backdoor’ for Chinese subcomponents entering the US market via European products.

Similarly, zero tariffs for European goods seem highly unrealistic. Tariffs are meant to generate revenue and the EU – ignoring US objections to value-added tax – is too significant an importer to the US market to be exempt from ‘contributing to the federal coffers’. Nor does the UK’s position seem dramatically different.

This doesn’t mean the EU must agree or lacks alternatives. Closer co-operation with China is one option but, as a citizen of one of the EU’s ‘new economies’ I believe such co-operation today is likely to require compromise with China’s eastern ally, Russia. I struggle to see how that would benefit central and eastern Europe or the Balkans – former satellites of an ally that openly dreams of our return to that status.

Tariffs as compensation for tax cuts

This brings us to Trump’s other economic goals: a not-too-strong dollar and lower interest rates. Achieving higher tariffs, lower rates and a stable currency without raising prices is simply impossible in today’s US economy.

The US federal budget expects revenues of around $5.5tn this fiscal year. Individual income taxes account for roughly $2.6tn, corporate taxes $4.7bn and capital gains taxes about $3bn. US imports in 2024 totalled around $3.5tn, with goods making up $2.8tn and services the rest. Imports from China were under half a trillion. At best, they might offset reductions in capital gains or corporate taxes. Meanwhile, the federal deficit, projected at $1.9tn, is likely to exceed that based on first-half trends.

This matters because new tariffs will inevitably raise the price of goods US voters consume. The announced tariffs will hit not only cheap Chinese goods but even cheaper products from other Asian manufacturers – think $5 t-shirts and socks – that US workers can hardly produce.

We must remind ourselves that voter dissatisfaction with rising prices partly swung the 2024 election against Democrats. Meanwhile, in 1981, when another Republican president, Ronald Reagan, arrived in office, he was mocked by media as a ‘second-rate actor’ with no intelligence. Today, he is regarded as one of America’s most successful presidents. That doesn’t mean he didn’t face fierce criticism for radically changing US policy but there’s a key difference.

Reagan welcomed capital inflows and opened the economy to foreign competition, driven by optimistic faith in deregulated US businesses succeeding globally. Unlike Trump, he didn’t shy from military confrontations with the US’s main global rival at the time. The differences – perhaps shaped by today’s reality with China – are clear. The Trump administration’s economic philosophy carries far more pessimism about America’s global role than Reagan’s did.

The mid-term elections could split Congress between Democrats and Republicans, ending the Trump administration’s ability to push through major changes. This may delay the implementation of decisions, but the administration wants them not just drafted but approved.

Source:Miroslav Singer

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Devin

Central Bank

Delegates from across the globe will descend on Washington DC on 21 April for this year’s International Monetary Fund-World Bank spring meetings. They will try to decipher if there is any rhyme or reason to the Trump administration’s economic policy chaos and the ensuing global financial market turmoil. They will leave as they arrived – scratching their heads with few answers.

Pity sensible economic policy-makers.

The US entered 2025 with good momentum and many projections anticipated annual growth of 2.25% to 2.5%. But given the huge uncertainties generated by President Donald Trump’s tariff chaos, forecasts are being marked sharply downward. Meanwhile, progress in bringing down US inflation is stalling and tariffs will worsen the outlook. Stocks tanked, yields soared and Trump mind-bogglingly brought into question the dollar’s safe-haven status.

Recession and stagflation are buzzwords of the day. The Federal Reserve will face a ticklish position – will it hold back due to higher inflation prospects or be more inclined to cut rates if the economy tanks?

Trump will most likely succeed in extending his 2017 tax cuts, though the timing is uncertain. What is clear is that debt and deficits are likely to rise – the US is now on track for continued 6% to 7% of gross domestic product deficits for the coming decade – despite the noise surrounding Elon Musk’s Department of Government Efficiency cuts and contrary to Treasury Secretary Scott Bessent’s delusion that growth will surge and deficits be cut to 3%. Continued high deficits will put upward pressure on rates and cause Treasury market indigestion on top of the turmoil generated by Trump’s misguided tariff policies.

Impact of tariffs will be felt globally

China’s deflationary challenges and other entrenched woes, such as housing and demographics, remain in place. Trump’s tariffs will bring US-China trade towards a standstill and others fear Chinese dumping in their markets. The authorities are providing modest stimulus but should use the considerable space on hand to do more. One shouldn’t underestimate China’s leverage over the US. President Xi Jinping will hardly back down. A full on US-China trade war will shift derisking to decoupling, amplifying global fragmentation.

The U-turn in Germany’s fiscal stance is highly welcome and long overdue given geopolitics, enormous fiscal space and a longstanding need to boost domestic demand and reduce external orientation. It is deplorable this turn was prompted by an apparent US abandonment of transatlanticism. But the economic impact will take time to unfold. German stagnation, along with debt woes in other major euro area countries, will hold European growth down, despite European Central Bank cuts, which may now go deeper than expected a month ago given weaker global growth, falling oil prices and a somewhat stronger euro.

Japanese prospects had appeared more favourable, but US automobile tariffs could deliver a blow. Canada and Mexico – America’s neighbours and close friends – may well be thrown into recession.

With Team Trump shamefully shuttering foreign economic aid and others cutting back assistance due to tight budgets, plus weakness generating lower commodity demand, Africa and the poorest nations will be hurt as well.

Pity the IMF’s World Economic Outlook forecasting team. It will have to mark down its global forecasts amid the height of uncertainty. The Global Financial Stability Report, pointing to the latest worldwide financial market turmoil, will rightly tell us that these events constitute a potentially lethal cocktail for significantly dampened investment and increased market volatility and short-termism, if not instability and panic.

The Fund’s fiscal minders will correctly rail with even more vituperation against excess leverage and the mistaken path many highly indebted countries, including the US, are embarked on.

Only China benefits if US backs away from the IMF

The IMF faces an existential moment. Project 2025 called for US withdrawal from the Fund and the administration has seemed to revel in retaliating against critics. The Fund’s activities vitally support US national security and economic interests and are a great deal for America. The only winner in any effort by America to back away from the IMF would be China.

Yet, the Fund’s very ethos – a stalwart defender of multilateralism and megaphone for fiscal rectitude – is in many respects contrary to Trump’s agenda. The Fund is supposed to use its bully pulpit to call out misbehaviour, especially for its largest shareholder. But it will encounter challenges in criticising a thin-skinned administration and trying to avoid putting a bullseye on its back. Mind the gap!

US leadership has been key for an economic order that produced decades of unprecedented global gains in living standards. Admittedly, that order has been fraying in recent decades and the US record is hardly without blemish. But the Trump administration appears intent on jettisoning it.

The IMF meeting delegates will inveigh against, fret about and seek answers to America’s sorrowful abandonment of the foundations that have generated global prosperity. They will flatter and plead with the Trump administration to change course to little avail and leave with perhaps no more clarity than with which they arrived.

At least Washington will be in bloom and the libations omnipresent!

Source:Mark Sobel

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Kevin Du

Economic

The European Investment Bank has been at the forefront of guiding and advancing the green and sustainable bond market, becoming the first issuer of a green bond back in 2007. Now the EIB has met another significant milestone by issuing the largest transaction so far under a new regulation for green bonds, dubbed the premium standard for the market.

This so-called ‘gold’ label is the European Union’s Green Bond Standard, a framework that became applicable at the end of 2024 and aims to enhance integrity and standardise disclosure for better comparability of green bonds. While the EuGBS label is voluntary, it has been viewed as the gold standard due to the strict conformity of the use of proceeds to the EU Taxonomy for Sustainable and Economic Activities.

In 2025, issuers have started to sell bonds under the EuGBS label. A2A, the Italian utility company, brought the first transaction in January with a €500m deal. This was closely followed by a €1bn trade by Île-de-France Mobilités, the French state public transport network, which became the first public sector borrower to issue an EuGBS-aligned bond.

But the most significant transaction has come from the EIB with a €3bn climate awareness bond in April. This was not only the biggest EuGBS bond to date but also the first from a supranational and a frequent borrower in the capital markets. The bond was more than 13 times subscribed, with demand exceeding €40bn and led by BNP Paribas, Crédit Agricole, Deutsche Bank and LBBW.

Green bond pioneer

‘This transaction – our first climate awareness bond aligned with the EuGBS – continues the strategy we began in 2007 when we brought the first green bond to the market,’ said Aldo Romani, head of sustainable finance at EIB, who structured and executed that pioneering green bond 18 years ago. ‘The main motivation of our initiatives was and still is to create a framework for higher transparency and accountability allowing investors to monitor the flow of EIB’s disbursements for green projects,’ he added. ‘This approach has been honed by the establishment of the EU legislative framework on sustainable finance and notably by the EuGBS.’

As the ‘EU bank’, the EIB has been a natural leader in the discussion about EU legislation on sustainable finance and the application of the EU Taxonomy regulation, which entered into force in 2020 to create a common set of definitions for sustainable economic activities. ‘In the green bond space, we started gradual alignment with the EU Taxonomy in 2019 and reached full alignment of taxonomy-eligible allocations with the taxonomy criteria for substantial contribution in 2022,’ said Romani.

The EIB has also been gradually adapting the non-taxonomy components of its CAB framework, notably allocation and impact reports for both stocks and flows, presenting already available information in accordance with the EuGBS regulation.

Its first transaction under the EuGBS label has been the next step in this journey. ‘Alignment with the EuGBS is the culmination of this process and enhances at the same time the value of non-EuGBS-aligned CABs,’ said Romani. ‘It clarifies to the market that we are using both instruments as part of an overarching process improving the quality of the information we provide to investors on the use of proceeds.’

Manual for others to follow

Going forward, the EIB will issue CABs both with an EuGBS label and without, with both instruments remaining aligned to the International Capital Market Association’s Green Bond Principles – a complementary set of voluntary guidelines for green bonds. However, the EIB, with its inaugural EuGBS transaction, hopes to have provided a manual for other issuers and public sector borrowers to prepare and bring their own deals under this label.

The EuGBS had previously been heavily criticised for setting a bar too high for issuers to meet. At a forum by OMFIF’s Sovereign Debt Institute in April 2023 – shortly after the entry into force of the regulation – one third of the attendees said the EuGBS was a ‘wasted opportunity’ for borrowers, highlighting the frustration among issuers in aligning with this new regulation.

‘The distance between the GBP and the EuGBS is not as large as it has been depicted,’ said Romani. ‘If you consider non-taxonomy requirements, there is a very big overlap between EuGBS and GBPs.’ If issuers realise this, it may lead to more issuance under this format. The key thing is that issuers have a template to follow from the EIB.

Source:Burhan Khadbai

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Gerik

Economic

Diverging narratives between politics and statistics

In a recent statement on Truth Social, President Donald Trump claimed that inflation in the U.S. economy has effectively disappeared. Citing falling gasoline, food, and mortgage rates, he asserted that the economy is in a transition phase following new tariffs and urged the Federal Reserve to lower interest rates promptly. His argument hinges on the belief that consumers have long awaited price relief and are now finally experiencing it.

However, the assertion contradicts current data. The Consumer Price Index (CPI) for March showed a 2.4% year-on-year increase—still above the Federal Reserve's 2% target. While this figure marks a moderation from the peak inflation observed in 2022, it remains higher than the 1.8% average inflation seen during most of Trump’s first term.

Fact-checking key claims

Trump stated that gasoline prices have dropped to $1.98 per gallon, labeling it the lowest in years. But weekly updates from the U.S. Energy Information Administration (EIA) indicate a national average closer to $3.13 per gallon. This clear discrepancy highlights a gap between political messaging and real consumer data.

In contrast, his remark about mortgage rates was more accurate. The average 30-year fixed mortgage rate has recently declined to approximately 6.83%, down from over 7% earlier this year. This easing in borrowing costs is partly driven by shifting market expectations about future monetary policy rather than broader deflationary pressures.

Inflation dynamics and the Fed's cautious stance

Although Trump’s rhetoric frames the economy as stabilizing, the Federal Reserve remains cautious. The U.S. labor market continues to show strength, with April’s employment report surpassing forecasts, suggesting that demand-side pressures remain resilient. This stable job market complicates arguments for urgent rate cuts, as strong employment tends to support ongoing consumption and upward price pressure.

The causal relationship between policy rates and inflationary trends underpins the Fed’s hesitancy: reducing interest rates too early could reaccelerate inflation, undermining previous monetary tightening efforts. Consequently, Fed policymakers are holding off until inflation decisively aligns with long-term goals.

Market expectations reflect this cautious view. The CME FedWatch Tool indicates a near-certain probability that the Fed will keep rates steady at the next policy meeting. Expectations for a 25-basis-point cut at the June meeting have fallen sharply—from 60% a month ago to around 40% now.

Political pressure vs. market stability

Trump’s remarks come amid broader tensions between his administration and the Federal Reserve. Just weeks ago, he publicly floated the idea of removing Fed Chair Jerome Powell before his term ends in 2026. Although he later walked back that statement following market backlash, the suggestion itself contributed to uncertainty about central bank independence.

A spokesperson for the Trump administration defended the president’s economic strategy, claiming that U.S. investment is surging, especially in domestic manufacturing. According to the White House, domestic fixed investment rose 22%, partly fueled by large-scale reshoring and tariff-induced shifts in global supply chains.

Yet, the debate continues: does this investment-led growth justify premature rate cuts, or are the inflation figures still too high to warrant monetary easing? The answer will likely unfold in the coming quarters, depending on whether inflation trends align with Trump’s optimistic messaging or with the Fed’s more measured analysis.

Policy rhetoric and economic reality remain at odds

Trump’s declaration of “no inflation” appears to be more a political narrative than an economic diagnosis. While certain price categories—like mortgage rates—have eased, broad inflationary pressures persist above the Federal Reserve’s target. The divergence between political signaling and statistical evidence reflects deeper tensions in how economic recovery is interpreted and managed.

Unless inflation retreats more decisively, and labor market conditions cool significantly, the Fed is unlikely to heed calls for rapid rate cuts. For now, financial markets remain aligned with central bank caution—not presidential insistence.

Source: CME FedWatch

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Devin

Economic

Donald Trump’s egregious comments about Jerome Powell, the Federal Reserve chairman, together with many other recent impulsive actions by the US president, have damaged the standing of the dollar. On that broad question, most economists and commentators on world monetary affairs are in general agreement.

Yet to assess what difference this might make to the way to the way the world’s reserve currency system works, we need to ask a further question. Can the politicians and central bankers behind the world’s number two reserve currency, the euro, turn it into a real contender to dislodge the US, say over the next 10 years, from its position of monetary supremacy?

Whatever happens, Europe will want to avoid hubris. European financial officials with long memories still recall with a shudder a statement by Yves-Thibault de Silguy, France’s enthusiastic commissioner for monetary affairs in the years before the euro’s birth, who said in 1996 that the single currency would be ‘quickly understood in New York and London, sooner than in Paris or Frankfurt, as the tangible sign of re-emerging European power’.

Although China’s economic size makes it a longer-term contender to take the dollar’s throne, the renminbi’s low share of international reserves, plus fundamental political factors, hold back its chances of becoming a serious shorter-term rival.

Figure 1. Euro is the world’s number two reserve currencyQ4 2024, %

Getting serious about euro internationalisation_1

Source: International Monetary Fund Currency Composition of Official Foreign Exchange Reserves

In three big areas – enacting a convincing joint economic policy to match pooled monetary policy, establishing sustainable economic growth and providing deep liquid markets for investors – Europe is still far away from that goal. The onus is now on Europe to show more energy and staying power on the long journey to internationalise the euro.

The currency starts off from a relatively high base of 20% of world reserves (Figure 1). But as commentators like Gary Smith have pointed out, this has remained broadly unchanged during most of the lifetime of the single currency.

Merz and Macron could provide new impetus

The leader with the greatest potential, at least in theory, to influence international currency matters is the new chancellor of Germany, Friedrich Merz, due to take office in just over a fortnight. Merz, together with Emmanuel Macron, now just two years away from stepping down after the French presidential election in April 2027, have a chance of providing new impetus.

Merz has made a start with the bold fiscal expansion measures for defence and infrastructure announced in the run-up to the agreement on a new coalition between Merz’s conservatives and the Social Democratic Party.

Coinciding with Trump’s undermining of the dollar, this has led to a general upgrading of international investors’ appraisal of the euro area’s future prospects. Financial markets’ optimism about Europe however seems to be directly proportional to onlookers’ geographical distance from Berlin, Paris and Brussels.

Underlining Europe’s predicament, the International Monetary Fund in its semi-annual outlook on 22 April lowered its growth forecast for the euro area to 0.8% in 2025 and 1.2% in 2026, both 0.2 percentage point lower than projected at the start of 2025. The IMF blamed Trump’s tariff policies for the general international downgrade.

As well as the most enticing opportunities, Merz arguably faces the gravest challenges. Spending the additional fiscal firepower without driving up inflation or causing disruption on ancillary European capital markets will be a difficult balancing act.

When Germany – in 1978 and 1991-92 – previously carried out poorly coordinated large-scale fiscal stimulus, the outcome was highly negative. In the first case this led to a German recession and the political demise of Chancellor Helmut Schmidt; in the second, to a near fatal implosion of the European Monetary System and another German recession.

Thoughtful European policy-makers such as Mario Centeno, governor of the Banco de Portugal and former chairman of the Eurogroup of European finance ministers, welcome the German package, but call for it to embedded within a well-considered European institutional framework

Unfortunately, many measures that would bolster the euro’s international status run counter to the fundamental leanings of Merz’s conservative supporters. Unease about the German Christian Democrats’ unplanned lurch to Keynesianism has been one of the reasons for Merz’s latest slide in opinion polls – hugely unwelcome for a politician still weeks away from forming his government.

Buttressing the euro’s status

Extending the Next Generation EU borrowing programme would be a logical way to capitalise upon global investor demand for the euro assets.

Supporting intelligent proposals by a working group reporting to the European Parliament to enlarge operational responsibilities of the European Central Bank and reinforce euro area market infrastructure would add to European resilience.

Promoting capital markets union to strengthen Europe’s market-orientated response to the climate crisis as well as to help finance infrastructure and defence projects is fully in line with Merz’s thinking – but faces institutional and political hurdles around Europe.

And taking further steps to promote banking union, for example by overcoming German hesitancy over a fully-fledged European Union deposit insurance scheme, would represent a major institutional landmark. All four of these measures would help buttress the euro’s status – but enacting each one of them, let alone all four together, would be an uphill struggle against well-entrenched resistance.

Last year currency experts Steven Kamin and Mark Sobel outlined the thesis that America itself rather than any outside player held the key to determining whether the dollar would suffer a decline in its international supremacy. Much more quickly than expected, Trump’s actions seem to confirm the Kamin-Sobel doctrine.

If the trend in coming years is to pick up further momentum and take on constructive shape, Europe will have to play its part in providing a viable dollar alternative. Can Europe step up to the plate? That is just one of the many open questions overhanging the future of the Old Continent.

Source:David Marsh

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Gerik

Economic

Strong job report contrasts with growing uncertainty

The U.S. labor market once again defied expectations in April, with 177,000 non-farm payrolls added, surpassing the Dow Jones estimate of 133,000. The unemployment rate held steady at 4.2%, in line with forecasts. Healthcare led the job gains with 51,000 new positions, followed by transport and warehousing, financial services, and social assistance. Meanwhile, federal employment fell by 9,000 as part of a federal workforce reduction program under the Department of Government Efficiency (DOGE).

This latest report signals continued resilience in employment, a crucial pillar of economic stability, even as President Trump’s aggressive tariff strategies begin to stir market unease. Employers, so far, have held back from mass layoffs, but weakening business confidence—attributed in part to tariff-induced costs and supply chain disruption—is raising red flags for future job stability.

Trump insists inflation is gone, calls for rate cuts

In response to the job report, President Trump reiterated his claim that inflation has effectively disappeared and again demanded rate cuts from the Federal Reserve. Posting on Truth Social, he wrote: “We are just in a TRANSITION PHASE, only just beginning!!! Consumers have waited for years to see prices fall. THERE IS NO INFLATION, THE FED SHOULD CUT RATES!!!”

However, this bold statement contrasts with the latest inflation data. As of March, the Consumer Price Index (CPI) was still rising at an annual pace of 2.4%, above the Fed’s 2% target. Although this figure has moderated from previous highs, it remains elevated by historical standards and does not support a case for aggressive monetary easing—especially while labor markets remain tight.

Fed expected to hold rates steady amid mixed signals

The Federal Reserve is widely expected to maintain its benchmark interest rate at 4.25–4.5% during its upcoming policy meeting. While the labor market is solid, inflation remains sticky, and uncertainty surrounding Trump’s tariffs on imports complicates the economic outlook.

The causal relationship between sustained employment growth (A) and persistent consumer demand (B) reinforces the Fed’s caution: as long as job growth fuels spending, inflation may remain above target despite isolated price declines. Cutting rates prematurely could undermine monetary credibility and reaccelerate price pressures.

Trump’s rhetoric positions inflation as a political, not economic, issue—using selective indicators such as gasoline or mortgage rates, some of which do not align with official government data. His assertion that prices have broadly declined is contradicted by CPI figures and core inflation measures that remain elevated.

Tariff policy introduces new risks to the outlook

Trump’s reassertion of tariffs as a core economic strategy adds to market ambiguity. While intended to protect domestic industry and encourage reshoring, tariffs also risk raising input costs and reducing consumer purchasing power, especially if retaliatory actions from trade partners escalate.

Businesses may soon face a dual squeeze: pressure from rising input costs due to tariffs, and shrinking consumer confidence amid price instability. This interplay between protectionist policy and inflation expectations is complex and volatile, suggesting that the path forward for both fiscal and monetary policy is far from straightforward.

Mixed economic signals hinder policy clarity

President Trump’s insistence that inflation is over and that rate cuts are warranted runs counter to both economic data and the Federal Reserve’s cautious stance. While job growth remains a bright spot, the broader picture—persistent inflation, falling business sentiment, and looming trade tensions—warrants prudence, not premature easing.

As the Fed balances political pressure with empirical evidence, it must navigate a policy landscape increasingly shaped by unpredictable fiscal decisions. For now, rate stability appears to be the most likely outcome, despite the growing intensity of Trump’s demands.

Source: Reuters

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Devin

Economic

In the trade negotiations with the US, Japan’s chief negotiator will not threaten Scott Bessent, US Treasury secretary, that selling Treasuries is an option Japan could consider. This is not because he cannot. It is because Japan’s elite knows full well the only reply this will trigger is the same as then Treasury Secretary John Connally gave to the G10 in August 1971, moments before the break-up of the Bretton Woods global financial system: ‘It’s our dollars, and your problem.’

You may accuse Team Trump of a lot of things, but lack of confidence is not one of them. And the more ambitious, old-school mercantilist, anti-free-market, anti-American factions of Japan’s elite cannot help but secretly cheer on the consistency and aggressiveness with which President Donald Trump is trying to break up not just the equilibrium, but the governance of global free markets.

Japanese private and public investors are cutting their US investments. This is not because of the usual tactical reasons – a change in the Federal Reserve’s policy expectations – but because strategic asset allocators and fiduciaries are urging the stewards of pension and insurance assets to reconsider the longer-term risk profile of ‘safe’ US Treasuries. Jamie Dimon, chief executive officer of JP Morgan, put it politely: the trade war risks eroding US credibility.

To put it in more blunt financial terms: global creditor nations, like Japan, will demand a growing ‘discount’ before buying US assets. Why?

Let’s take Team Trump by its words. After barely 100 days in office, it is crystal clear they want to engineer a fundamental change in how America interacts with other nations. The long-established covenants and coordinated governance of global trade and finance are being ripped apart from its very centre.

For Japanese and all global stewards of capital, the question is not whether this will be a good thing or a bad thing in the long run. The immediate question is how to manage the new risks now forced by this transition. Clearly, the risks of this experiment not working out or being sub-optimal to the previous one are not zero.

Investors will demand more compensation

Japanese investors are patient, but like all investors the longer the ‘end game’ remains elusive and Team Trump refuses to present a consistent and credible plan of what the new covenants and governance of the next global system should look like, the greater the compensation they and all global savers will demand from US assets.

‘Moving fast and breaking things’ is not a model global fiduciaries can adopt. Long-term capital needs prospects of long-term stability to thrive. Predictability and logic are essential.

The risks of owning US assets are going up, so the world will want to be paid more for owning them. This means higher US bond yields, lower valuations for US equities and, of course, a lower dollar. This is the ‘Make America Great Again discount’.

An added consideration is the basic linkage between trade and capital flows. Yes, the US has the world’s largest and deepest capital markets. The mirror of the now super politicised US trade deficit is the US capital account surplus. A significant part of this surplus is the recycling of global exporters’ profits from selling to Americans, a real-world liquidity boost to US capital markets and an important force making US financial firms the dominant (and most profitable) in the world. Now that tariffs will undercut global exporters’ sold-to-Americans profits, this recycling of liquidity will dry up.

Simply put, if Toyota cannot earn US dollars anymore, its deposit balances at JP Morgan and other US banks will drop, which in turn means reduced funding for US financial intermediaries, which means they will have to cut their US assets and Treasuries.

Make no mistake: the linkages between global trade, the global savings glut that free trade enables and US financial assets having enjoyed a ‘premium’ over the past decades are the real risks Japanese and global stewards of capital are now forced to price for.

Importantly, the question is not the always topical ‘are Japanese or Chinese investors selling, and if so, how much?’ More important is at what price/yield they will be prepared to come back to US markets.

Today, it is impossible to know how high the MAGA discount will have to be. All we do know is that it will continue to rise until we get a new mutually agreed covenant on how sovereign nations are to interact with the US. Until then, the most likely ‘safety valve’ is poised to be significantly weaker US dollar.