Remember when tariff threats were a boon for the dollar, Treasurys were a haven from the volatility associated with a global trade war and US stocks were the only equities game in town?
That dynamic was turned completely on its head over the past two or three months. As the severity, scope and, just as importantly, the haphazard vindictiveness, of the Trump administration’s approach to the trade war became clear, a stunned world began to shun US assets. The perception that the rule of law’s under siege in America didn’t help.
Now we’re in a new paradigm. When trade tensions abate, the dollar can rally, Treasury yields can fall and US equities can enjoy a reprieve. That’s how the picture looked early Wednesday, with the greenback relatively supported, US yields lower from the belly on out the curve and stocks bid a second session.
Great, right? “A brighter day,” as Reuters put it, in one of their mailers. I don’t know, actually.
For one thing, the size of the daily swings in US equities is far too large for comfort. A market that’s moving 2% every day (or every other day or even every three days) isn’t what you want. That’s not stability.
Beyond that — and this speaks to the points above — it’s not a good thing when the dollar and Treasurys trade in tandem with risk sentiment. Generally speaking, the world’s reserve currency and interest-bearing versions of it (which is all Treasurys are), shouldn’t need “risk-on” to find their footing. That’s ass-backwards.
Normally, the world’s a friendlier place when the dollar’s back-footed, and vice versa. Traditionally, “dollar down” means “risk-on,” better global liquidity and easier financial conditions.
More recently, by contrast, “dollar down” was a sign investors were still offloading USD assets and otherwise attempting to trim exposure to America on concerns the nation’s overtly adversarial approach to trade and “institutional erosion” at home have undermined the fundamentals.
As I’ve been at pains to communicate, those fundamentals — e.g., America’s commitment to its treaty obligations, fidelity to democratic governance, religious dedication to the rule of law, and so on — have never been seriously questioned.
Typically, when we talk about “the fundamentals” in the context of, for example, US Treasurys, when mean things like yield differentials versus other G7 paper and bonds or, say, overwrought deficit hand-wringing. Not (not, not) worries that America might annex Canada. Or that the Fed Chair might be escorted out of his office at gunpoint for not cutting rates. That’s crazy sh-t. Science fiction. Or not. Because here we are.
I can’t emphasize this enough: The notion that meaningfully higher Treasury yields are insufficient to entice demand for USD bonds is an existential problem if it becomes a structural feature of the market.
Sure, that can, and will, be the case from time to time even in the normal course of business. So, for example, maybe the market’s being asked to underwrite a lot of supply during a week when the IG slate’s crowded, and even in the presence of a meaningful concession, you get an auction tail. No big deal.
What you don’t want, under any circumstances, is to wake up and see longer-end US yields sharply higher with the dollar sharply lower. All Scott Bessent’s “it’s just the basis trade blowing up” excuses aside, that suggests an emerging market-style dynamic: Higher yields aren’t just “compensation,” they’re a risk premia.
That’s terrifying in the context of US Treasurys. Why? It raises surreal, definitional questions. What’s the definition of “risk premia”? It’s the return in excess of a known risk-free asset. How’s that return determined? Why do we say it’s “known”? Well, because the risk-free asset is just Treasurys.
See what I mean? This situation — the ass-backwardness of the current macro-market zeitgeist, defined as it is by a positive correlation between the dollar (and USD bonds) and risk sentiment — has no foundation. There’s nothing under there. If the dollar’s a high-beta currency and the yield on US Treasurys is something other than the risk-free rate, we’ve lost the reference point(s) for pretty much every relative term in the financial lexicon.
Again, this has to stop. As far as I can tell, the philosophical implications of recent events haven’t occurred even to people steeped in markets, let alone to anyone on Capitol Hill. We’re just floating around untethered right now.
Let me drive all this home as best I can. Whether you’re cognizant of it or not, the prices you see on your terminals reference and rely upon a set of elemental — almost primordial — assumptions about the dollar and Treasurys. If those assumptions no longer hold, those prices will cease to have any meaning.
It seems to me that the market has now become another play thing for Trump. It climbs or dives at his command. If he’s saying things it likes, it goes up. If he’s saying things it doesn’t like, it dives. For a narcissist, this provides him with unimaginable power and control over something that is unimaginably powerful in the global context. He must feel incredibly powerful at this moment.
And there’s no SEC to worry about if you’re in his inner circle getting the tweets/truths before anybody else. Or in JPMorgan’s inner circle when Bessent comes for a visit.
Untethered and then there’s all the other global negative drivers like climate change and authoritarian land grab wars. It’s engendered new meaning to living on a knife edge.
I know you’ve explained this a million times I’m just checking that I’m following your conclusion: the elemental assumptions about treasuries would be that they are risk free (binding contract) and that we abide by rule of law and don’t do crazy sht and that the currency doesn’t jump around like a memecoin? And that underpins all the other assumptions about assets?
Did you listen to the new episode of The Ezra Klein Show? Would you argue that even during prior periods of illiberalism that Dr. Hahn brings up that the integrity of the United States was not questioned the way it is now? Or maybe wasn’t as existential to the global economy and monetary system?
Equity risk premia and hence fair valuation in certain models are usually calculated based on treasuries as the risk free asset. This is reasonable if there is no credit risk or liquidity risk. If these assumptions don’t hold then such calculations are obsolete.
It fits that the greatest confidence game of all time is being torn down by the greatest con man of our generation. Time to close the lid on my bomb shelter.
How many times can Trump get away with his antics before the house of cards tumbles down? The answer my friend, is blowin in the wind. I would posit the winds are picking up.
Price discovery is gone. What we have is a bad gambling casino run by a bad casino owner.
“New shooter coming out!” Bettors scramble to place bets. nothing is solid. The center cannot hold.
Don’t cry for me Argentina.
Feels like certain US leaders are feeling for the edge of their envelope of power. The Powell saga is yet another example. Fabricate the crises, boil the frogs.
The “philosophical implications of recent events haven’t occurred” to most people. Period. They never do b/c most people run from thinking deeply about anything. This time, on the Street and on the streets, the practical effects of what you describe well will materialize in scary ways. For everyone. Maybe then people will take to heart (and hopefully not via a bullet to the heart) what it means when the rule of law disappears.
And, as Krugman reminds us this morning, add in the insider trading: https://paulkrugman.substack.com/p/cronyism-capitulation-and-chaos
Thanks for that link. And if that type of insider info is being shared with bankers, what’s stopping this type of behavior happening amongst senate or house members?
Thanks for highlighting these (the philosophical implications of UST prices containing risk premium elements).
Relatedly, read an article arguing how unlikely for USD to be dislodged as the world reserve currency (citing the depth and liquidity, no alternative, institutional structure, operational habits etc.) in the foreseeable future.
Seems like this Administration is accelerating towards something truly combustible, out of which a new global monetary order (or lackof) will be born?
If you can be anything why not just be bearish. Bearish on our democracy, our institutions, our global alliances, broadly life and of course the market.
I wanna sell it all and buy a cabin in the woods.
Are cabin in woods prices affordable yet? ?