Trump has created a secure, stable environment for financial markets
The stock market has grown indifferent to Trump's tariff antics. However, the bond market tells a different story. The former haven of global financial systems has experienced a significant shake-up, with investors increasingly seeking alternatives.
When a nation's finance minister feels the need to assure the safety of the debt, it's usually a bad sign. Indeed, such assurances often come when the country is teetering on the edge of default. So, it was no surprise when US Treasury Secretary, Steven Mnuchin, felt compelled to affirm that the US would never default - a claim that raised eyebrows, given the country's debt, which amounts to an astounding $28 trillion in government bonds.
But is Mnuchin's assurance credible? Not many countries harbor such colossal debt as the US. Historically, the US enjoyed the status of a "safe haven," a place where investors could securely stash their cash. However, Trump's policies, which include widening the deficit by an additional $3 trillion over the next decade due to tax plans and imposing tariffs, have eroded this status.
As a result, investors have grown increasingly wary of Trump's policies. LBBW chief economist, Stefan Bruck, who once served as a rating analyst at S&P, the agency that downgraded the US from the top rating "AAA" back in 2011, stated, "The safe haven has been mined."
A Decoupling Act
The skepticism is manifest in the decoupling of US bond yields and the dollar. For years, both had moves in parallel, reflecting a strong US economy. However, since mid-March, they have largely parted ways, with the 10-year US bond yields (Treasuries) rising from 4.16% to 4.42%, while the dollar has lost 4.7% of its value.
Under normal circumstances, higher yields indicate a robust economy, attracting capital inflows to the US. But if yields rose due to concerns about US debt and political uncertainty, the dollar might weaken concurrently. This pattern is characteristic of emerging markets, according to UBS's head of G10 FX strategy, Shahab Jalinoos.
The disbelief in Mnuchin's statements was underscored by Moody's downgrade of the US rating from AAA to AA1, and the widening of Credit Default Swaps (CDS) - a form of insurance for investors against debtor default - to levels equivalent to Greece and Italy. In recent US Treasury bond auctions, the country faced difficulties finding enough buyers, suggesting that the markets are unconvinced by Mnuchin's words.
The New Reality
For many professional investors, these movements represent the signs of a broader crisis of confidence in the US. According to Michael de Pass, head of FX at Citadel Securities, "The strength of the dollar is also based on the integrity of institutions: the strength of the rule of law, an independent central bank, and predictable policy." Trump erodes all of this.
If Trump desires a weaker dollar to make exports cheaper, he likely doesn't want a structural crisis of confidence in the dollar. The US's status as the world's reserve currency allowed it to achieve its current size and power. Losing this status would diminish Trump's negotiating power - something the self-proclaimed "Dealmaker" would hardly relish.
Even though shifts in the leading currency might take years and begin before Trump, analysts see him as a catalyst. Investors are now exploring alternatives to the dollar, and Goldman Sachs has identified the cities of Frankfurt, Tokyo, and Zurich as the long-term beneficiaries of this shift. They recommend building positions in euros, yen, and francs, and another asset class, gold, is also gaining attention.
The increasing skepticism towards US Treasury Secretary, Steven Mnuchin's assurance of no default, has led professional investors to consider alternatives to the US dollar, given the country's colossal debt and Trump's policies that have eroded the US's status as a "safe haven". As a result, they are investigating cities like Frankfurt, Tokyo, and Zurich, recommended by Goldman Sachs, and also turning their attention to gold, as they seek to diversify their investments and decouple from the US currency. This shift in investor behavior follows the decoupling of US bond yields and the dollar, underscored by Moody's downgrade of the US rating and the widening of Credit Default Swaps, suggesting a broader crisis of confidence in the US and its economy.
