Trump's Policies
Do not play the bounce in US and global cyclical assets as Trump backpedals from the trade war. China will talk, but the pace will be slow and the outcome disappointing. Fiscal stimulus will surprise marginally in the EU, China, and even the US, but still may not rescue the business cycle.
This report is an edited transcript of our recent conversation with Mr. X and his daughter, Ms. X, who visited our office to discuss the rapidly evolving economic outlook. The US and global economies are likely to enter a recession this year barring a decisive tariff reversal or the passage of significant fiscal stimulus. Even the latter is not clearly bullish for stocks, as it risks a stagflationary outcome. Investors should be underweight stocks versus bonds and should respond to clear signs of stagflation by lowering fixed-income portfolio duration. We continue to recommend defensive equity sector positioning, an overweight stance toward value stocks, an underweight stance toward small caps, and gold over cyclically sensitive commodities.
The policy-induced decline in consumer confidence has spread to businesses and investors, increasing the probability of a recession even if the administration reverses field on its aggressive tariff measures. We reiterate our defensive asset allocation recommendations.
Upgrade the odds of a full-scale war in the Taiwan Strait from 5% to 10%. Rapid escalation of US-China economic war raises the probability of tensions spilling into the military-strategic domain. Investors should buy insurance against this tail risk while it is cheap. Meanwhile, use this year’s trade shock and equity volatility to increase allocation to EM manufacturing states.
Fed Chair Jay Powell’s remarks yesterday were in-line with our base case expectation that the Fed will not cut rates proactively in the face of rising tariff-driven inflation.
This week, we look at the sustainability of the HKD peg as the next whale to move markets, given what is happening to tariffs. After careful analysis, our bias is that it is here to stay. With the DXY dipping below 100, we are likely to see a rebound, which is actually bad news for the Hong Kong region of China, since it will tighten financial conditions. We have no new short-term trades, but if the peg broke, you want to be short HKD/JPY.
Barring a dramatic further de-escalation of the trade war, the US and much of the rest of the world will enter a recession over the next few months. Investors should remain defensively positioned for now.
While the market welcomed the pause in Liberation Day tariffs, we believe investors are overly optimistic about the relief from this Trump-driven uncertainty. Even with the pause, current tariff levels remain higher than they were in January. Elevated tariff levels are likely to be inflationary, which could explain the recent spikes in US Treasury yields. Currently, Congress does not have a veto-proof majority to rein in President Trump’s tariff policies, meaning the trade war with China will persist.
China’s aggressive retaliation against U.S. tariffs will enable President Trump to shift from punishing allies and redirect the trade war toward China. If Beijing does not react to the latest tariffs by doubling its fiscal stimulus, it indicates they are planning something different, as China will encounter economic destabilization. The likelihood of a hybrid military pressure on Taiwan will rise.