Rhetorical assaults on postwar alliances and security among the developed economies have created conditions for a classic risk off moving across asset classes.
A rare simultaneous selloff in the dollar, Treasuries and equities comprise what the investing community has labeled the sell America trade.
That trade is similar to what occurred last year between April 2 and April 8 following the announcement of sweeping tariffs, when long-term relationships such as that between the U.S. dollar and long term bond rates broke down.
Following that announcement, rising yields across the maturity spectrum caused the administration to walk back its initial announcement. The 14.03% average tariff rate through November is far less than the rates announced in April.
We tend to think something similar will happen over the next few days and weeks.
But during that time, there may be excessive volatility across asset classes and a tightening of financial conditions, which is at cross purposes with recent interest rate cuts by the Fed.
While there is no clear direction in the emerging crisis between the European Union and the U.S., behavior among investors continues to push capital into assets like gold and silver because of a general reassessment of economic and geopolitical risk that predates tensions over Greenland.
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State of play
The price of gold has increased by 79% since January last year, signifying increased risk.
And in a move potentially worse for domestic consumers and foreign investors, the dollar has lost 10% of its value over the year.
Both suggest upside risk to rising prices and further inflation.
Stress in the markets
While U.S. stock prices have seemingly been invincible to geopolitical events, the bond market has been selling off since late November. The increase in long-term interest rates is the pricing of additional risk even as the Federal Reserve has moved to reduce its policy rate.
The 30 basis-point increases in both 10-year and 30-year Treasury yields suggest concern over inflation should the current trade spat turn into a full-blown trade war between the U.S. and other developed economies.
America’s developed-market trading partners are also the major sources of financing U.S. budget deficits. Further selloffs and the dollar’s decline would reduce the attractiveness of U.S government and corporate debt, adding to the cost of funding increased U.S. debt and investment in its economy.
The takeaway
Between the increased risk priced into the bond market and this week’s drop in the stock market, financial conditions have become less accommodative.
As of Tuesday, our RSM US Financial Conditions Index has moved lower, to one standard deviation above zero.
While one standard deviation suggests accommodation, the prospect of increased uncertainty—should the geopolitical stress not be resolved—would act to increase volatility and the cost of credit and capital.
