Trump has successfully blown up the global trading system

While Wall Street settled a little on Monday, there’s still a question mark over the future of US financial markets raised by the rollercoaster mayhem in share, bond and currency markets this month.

The cause is obvious. Donald Trump’s April 2 “Liberation Day” ignited a massive burst of volatility, with his subsequent pauses and exemptions generating wild movements in all the markets.

The sharemarket initially plunged before the 90-day pause in “Trump’s reciprocal” tariffs saw a steep, albeit partial, bounceback. Bond yields spiked at a rate not seen since the earliest days of the pandemic in 2020 before subsiding slightly on Monday in response to the decision to exempt, for the moment, electronics from the tariffs.

Donald Trump’s tariff policies have set off a massive burst of volatility.Credit: Bloomberg

The US dollar has been sliding against the trade-weighted basket of its (former?) major trading partners’ currencies since April 2.

Indeed, after a “Trump bump” in the period between last year’s US election and Trump’s inauguration, it has been sliding all year, but the decline accelerated after the package of universal and “reciprocal” tariffs was unveiled.

It is highly unusual – it has only been seen during financial crises in the past – for US share prices, bond yields and the dollar to fall simultaneously.

Normally, there is an inverse relationship between share prices and yields, and the dollar and yields usually strengthen in times of stress. That’s where their “safe haven” status has been demonstrated in the past.

It would seem, as the post-mortems on what occurred over the past fortnight roll in, that the US flirted with a financial crisis during the most intense period of selling in the immediate wake of the tariffs announcements but didn’t get close to the levels of stress seen in March 2020, when the US Federal Reserve Board threw a kitchen sink of measures at the markets to avoid a complete meltdown of the system.

The fear levels within the markets were, however, still quite extreme.

The VIX index, sometimes known as the “fear index”, which measures volatility in the sharemarket peaked above 60 last week.

The only time in the past 20 years where the index has closed above 50 (which it did on Monday last week) was during the worst days of the 2008-09 global financial crisis. The long-run average for the index is just under 20.

Trump has successfully blown up the global trading system. America ... will never be as trusted as an ally or trade partner again.

The Merrill Lynch Option Volatility Estimate, or MOVE index, which measures implied volatility in the US Treasuries (government debt) market, also jumped from 104.7 on April 1 to 139.9 on Tuesday last week. Before the tariffs were revealed, it was trading at around 91.

Both indices settled back on Monday – VIX at just over 30 and MOVE at 132.5 – but are still way above their longer-term averages.

The spike in volatility and slumps in markets has been attributed to not just sharemarket investors responding to the tariffs but the unwinding of popular leveraged trades in the bond market by hedge funds and other traders as unnerved by the spike in bond yields and fearing margin calls they scrambled to cash out their positions.

The US dollar has fallen more than 4 per cent this month, suggesting that foreigners are taking their money out of the US.

That may have amplified the surge in yields – at one point last week, the yield on the benchmark 10-year bond had jumped more than half a percentage point in four trading days – but it doesn’t explain why the dollar has fallen more than 4 per cent this month, taking its decline this year to almost 9 per cent.

The unusual sell-off across the three main US financial markets suggests that, while the tariff reveal might have been the catalyst, something more secular may be occurring.

The US economy, which was powering along relative to the rest of the world before Trump regained the presidency, with very low levels of unemployment and a receding inflation rate, has some significant vulnerabilities, most notably its deficits and debt.

If the Senate Republicans’ budget bill is a guide, Trump’s new tax cuts and spending measures will increase the deficits and, according to the Committee for a Responsible Federal Budget, add as much as $US5.8 trillion ($9.2 trillion) to the $US36.1 trillion of government debt by 2034.

Add Elon Musk’s frenzied attack on the US government’s agencies and then Trump’s chaotic trade war on everyone – friends and foes alike, but especially China – to the mix, and it shouldn’t be surprising that investors are losing confidence in the outlook for the US economy.

Indeed, Americans expect the economy to slow and even fall into recession while also expecting inflation to rise significantly. That would be a recipe for stagflation or lower growth with higher inflation and interest rates.

If a stagflationary recession were to eventuate, it would be self-inflicted, with Trump’s shambolic roll-out of his tariffs, government job-shedding and immigration policies to blame.

In the circumstances, why would foreigners – or even US investors – want to hold US assets when even Treasury bonds, regarded as the world’s safest securities, have been transformed into volatile and risky assets?

The depreciation of the US dollar suggests that foreigners are taking their money out of the US and, given the movements in other currencies, shifting it to Japan, Germany and Europe.

US Treasury Secretary Scott Bessent said on Monday that he didn’t think there had been any “dumping” of US Treasury bonds by foreign investors or governments. He also said he thought the declines in bond prices (which have an inverse relationship with their yields) were due to de-leveraging.

There has been speculation that China, the second-largest foreign holder of Treasuries behind Japan, may have been selling some of its $US760 billion of bonds to undermine the dollar and help raise US yields and interest rates.

There’s no evidence of that – China would probably crystallise large losses if it dumped large volumes of the bonds into the market – but it has been reducing its holdings steadily over the past decade from their peak of $US1.3 trillion in 2013.

China has a particular reason to reduce its exposure to US assets and the dollarised global financial system, but other central banks and their governments, too, have motivations to reduce their US holdings.

The increased use of the dollar’s dominance to impose financial sanctions, most dramatically the freezing of Russia’s foreign exchange reserves held offshore, has unsettled even some of America’s traditional allies.

America’s stretched finances and the chaos, unpredictability and economic illiteracy of the Trump administration – evidenced now on a near-daily basis by the backdowns and exemptions from tariffs being announced in social media posts – would also be off-putting to foreign investors.

Trump has successfully blown up the global trading system. America, regardless of the nature of successor administrations, will never be as trusted as an ally or trade partner again.

It has taken Trump less than three months to transform external views – and the internal condition – of America and its economy.

Bessent was relying on a convention that the US dollar would strengthen in response to the tariffs to blunt their inflationary effects. Instead, he’s got a depreciation that, if it persists, will make imports even more expensive.

If foreign investors are less likely to buy US Treasuries, the reduced demand means US interest rates will be higher than they would otherwise be – at a moment when the tariffs will be pushing up inflation and interest rates and even as US government debt levels are exploding.

The US needs to refinance more than $US9 trillion of maturing debt this year – debt that was issued when interest rates were near-zero – excluding whatever the Republicans might add to the issuance of new debt.

If what is developing within the US markets is indeed secular – an expression of the rest of the world’s loss of trust in the US, its economy and its management – America’s privileged credit status, where its government’s debt has always been regarded as risk-free, could be gradually withdrawn.

That would have unpleasant implications for its markets, the cost of servicing levels of government debt and Americans’ standards of living that are only sustainable because of its credit status and the primacy of the dollar.

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