Sigh, Chaos Continues (11)

Rates markets are starting to act unmoored, with long end Treasury and gilt yields rising. I am not in any position to offer an insider’s view of what is happening now, but I will just offer my impressions based on historical experience.

At the time of writing, China retaliated to the 104% American tariffs with a 84% tariff, and the EU is heading for a vote on their retaliation. At the same time, the White House administration is digging in and showing no visible interest in finding an off ramp. The American-Chinese tariffs have moved into the range where we are in a de facto embargo situation instead of merely a trade war. Supply chains are going to break rapidly, and will unravel long before the results show up in lagging economic data. At the same time, it is unclear that Trump will allow negative economic data to be printed — the truth is the first casualty of war.

There is a certain amount of excitement about leveraged basis trades blowing up in the Treasury market. My bias is that the damage from such trades can be contained to a few unfortunate funds (we always lose a hedge fund or two on major market moves). The real worry is credit. However, the wild nature of the tariff war means that there are a lot of potential credit skeletons in closets on top of the credit risk posed by failing financial market players. The “optimistic” interpretation explaining the rise in Treasury yields is that people are selling what they can. The reason not to be too optimistic about this interpretation is that forced selling is a sign of credit risk.

It is extremely likely that Americans with equity exposures will be envious of the Westminster parliamentary system. The Brits were able to remove the barmy Liz Truss quickly before permanent damage sunk in, while the Republican-controlled Congress is unable or unwilling to moderate Trump. Otherwise, there is no sign that any economic bad news will divert his course — and sources of bad news will be suppressed.