Will the last investor to leave America please turn out the lights

The damage from Trump’s trade war is far greater than the losses in stocks, bonds and the dollar seen so far.

The general flight from American assets stood out during a turbulent week. Picture: AFP

When market veterans gather, the talk often turns to memorable crashes: Where they were in 2020, 2011, 2008, 1998 or, for the older among them, 1987. Last week should join that list. Where were you when investors fled America?

The week was full of thrills that will be more fun to look back on than they were for those trying to trade them. Stocks had among their biggest-ever two-day drops and one of their largest one-day rises, whipsawing investors. Meanwhile, the US dollar plunged and Treasurys flashed warning signs of deeper trouble.

But what really stood out was the combination of moves, the flight from American assets in general. Stocks, bonds and the dollar all sold off at once.

There was a lot more going on than just day traders buying and selling on Truth Social posts. ­Investors who want to plan for the future need to take a view on three distinct drivers of what happened: trade, debt and de-Americanisation.

Trade, or rather US President Donald Trump’s attack on it, provided the basic reason to sell. His delay of the bizarrely calculated additional tariffs on countries other than China offered midweek relief, and Friday night’s exemption for iPhones and other electronics will offer further respite.

But investors quickly went back to working out the damage from the tit-for-tat trade war across the Pacific. That is in ­addition to his baseline tariff of 10 per cent, even on countries with which the US runs a surplus.

Stocks naturally fell as Wall Street strategists upped their probability of recession. The S&P 500 ended the week higher than it started, but remains well down from the tariff announcement the previous week. Notably, the US dollar and Treasurys continued selling off even as stocks ­rebounded.

The US Federal Reserve may be less willing to cut than it ­usually is in a downturn because of the inflationary effects of tariffs. By the end of the week futures priced in fewer rate cuts this year than at the start, despite a slower than expected inflation report.

A more hawkish Fed might justify higher bond yields, helping ­explain some of the rise in the 10-year yield (and fall in prices).

Debt reared its head early in the week as hedge funds began to liquidate trades deep in the plumbing of the financial system. The unwinding of leveraged positions drove big swings in a usually benign corner of interest rates known as swap spreads. This led to heavy selling of Treasurys that drove up yields and threatened to force more selling.

The prospect of a self-fulfilling spiral of selling put investors and regulators on edge as a 2020-style panic in the bond market suddenly appeared possible. Trump reversed course to prevent the worst.

But investors are aware of the danger of a near-trillion-dollar hedge-fund unwind. That in itself is a reason to reduce Treasury exposure, at least until hedge-fund positions are cleaned out.

De-Americanisation kicked in as investors watched the chaotic policymaking from the White House, but it wasn’t only about the US losing its aura of economic competence. Far from strengthening as bond yields rose, the US dollar has fallen sharply. On Friday, it reached its weakest level since 2022.

Europe and China are expected to stimulate their economies, which will help offset tariff damage. But the US’s giant tariffs amount to a large tax on consumers, slowing growth even before the hit lands from uncertainty about what happens next. A relatively weaker US economy should mean a weaker US dollar.

Worries about the independence of the Fed have arisen as the administration asserts its right to fire the heads of independent agencies – an issue that is likely to head to the Supreme Court.

A win for the White House would probably give it the power to fire Fed governors. That would call into question their willingness to make politically unpopular decisions.

On top of that, investors were all-in on the idea that the US was exceptionally strong. So there is a lot of foreign money to come out of US assets.

“US assets are losing some of their safe-haven status,” said Jack McIntyre, a bond-fund manager at Brandywine Global. “It’s ­another way of saying that US ­exceptionalism has peaked.”

Some big foreign investors now want a premium to buy US assets because of the risk of the US confiscating capital in some way. “The tariff gambit will fail to achieve its goals and they may have to revert to modifying capital,” said one large Canadian ­investor, saying once-unimaginable taxes on foreign capital flows or repatriation of investments now had to be considered.

Stephen Miran, chairman of the Council of Economic Advisers, has in the past suggested a “Mar-a-Lago accord” that could charge for foreign reserves held in Treasurys. This would amount to a default.

On Monday, he instead proposed that allies could avoid retaliating on tariffs or simply cut a cheque to the US to pay for the American military and the dollar’s reserve status. That is unlikely to be popular in countries like France. They – correctly – think the greenback’s special status gives the US an unfair advantage through cheap borrowing, the opposite of Miran’s view.

It’s hard to unpick how much damage each of these issues did. I think most of the moves of the past week were due to the tariff shock to the economy, combined with the unwind of hedge fund leveraged positions and a starting position of too much foreign money in US dollars.

But the fall in the US dollar is at least in part about a loss of faith in America. If that carries on, US markets have a long way to fall as foreigners flee.

The Wall Street Journal