2025-05-19 16:31:26
Hi everyone - this is Alf, the CIO of my macro hedge fund Palinuro Capital.
I hope you're having a great day.
In January the dream of launching my own macro hedge fund became reality.
And I have to thank this beautiful TMC Substack community for it.
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Every two weeks, you will receive an update on the macro themes we are watching and the track record at Palinuro Capital.
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And now, to today's macro research piece.
On Friday, the credit agency Moody’s downgraded the US rating by one notch to Aa1 (equivalent to AA+).
By now, you’ve probably read tens of opinion pieces arguing this is the beginning of the end, and that there will be dire consequences for the US Treasury market.
In this piece, you’re going to read a more sober and data-driven approach to this downgrade.
The first thing to understand is why Moody’s downgraded the US: ‘’ Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest cost’’.
The mainstream take here is that this makes sense because the US will never be able to repay its debt and because interest costs have now exceeded $1 trillion per year.
Once you understand the monetary system, both these assertions don’t make any sense:
Any government doing deficit spending and issuing bonds in its own currency (like the US) is not walking into an abyss of doom – it’s just choosing to stimulate the economy by printing money for the private sector.
It doesn’t have to repay anything – if it tries that via budget surpluses it will cause the opposite effect and end up hurting the private sector (via higher taxes).
The process of fiscal deficits creating money for the private sector is explained in the T-Account chart.
Step 1 is the government blowing a hole in its balance sheet to print money for the private sector (aka deficits), which adds net worth for households and corporates which see their net bank deposits increase. These deposits end up at banks, which in turn also see their assets (reserves) increase.
Banks will then swap these reserves for bonds at auctions where the US governments funds its deficits via issuing bonds and primary dealers (banks) plus foreign investors show up to buy bonds – step 2.
Ok fine, ‘’US debt levels are too high now’’ is a groundless worry touted by rating agencies and mainstream commentators but surely paying $1+ trillion in interest costs must be a scary proposition?
Not really: for every $ the US pays for interest on debt, there is an investor making $ on risk-free interest rates she is collecting by owning Treasury bonds.
Repeating this concept is useful to demystify the monetary system: yes, government debt and US interest payments are rising but it’s not like the US needs to ‘’choose’’ between spending on interest and spending money for healthcare – the government balance sheet doesn’t work like ours.
The real limitation to uncontrolled deficit spending is inflation and scarcity of resources (2021-2022 prime example) and not some budget constraints typical of a household.
Ok, but how does the Fitch downgrade affect investors and market participants?
The key point is that US Treasuries are now rated AA+ instead of AAA.
US Treasuries are the most widely used form of collateral in the world due to their high rating, liquidity, deep repo market and solid democratic foundations/rule of law.
Does the downgrade affect that?
Commercial banks are huge buyers of Treasuries: they use them as regulatory liquid assets (HQLA), as collateral and also sometimes as an asset to hedge interest rate risk on their liabilities.
The Basel regulatory framework introduced 10 years ago has 0% capital requirements for government bonds rated between AAA and AA- for its standardized approach: the downgrade to AA+ wouldn’t make any difference. Most banks actually choose an internal-rating based (IRB) approach based on internal models and in that case most jurisdictions apply an exception for any investment-grade rated domestic government bond which automatically assigns them a 0% risk weight.
Bottom line: for banks this downgrade makes no difference at all.
Treasuries are also widely used as collateral in repo transactions: for instance, pension funds and insurance companies lend their unsecured cash parked at a bank against collateral to upgrade the safety of their ‘’cash’’ deposits in a so-called reverse repo transaction.
A secured loan with UST as collateral (e.g. reverse repo) is safer than parking cash unsecured at a bank.
Does a downgrade affect the collateral status of US Treasuries?
The table above shows the Basel committee recommended haircuts for repo transactions.
As you can see, bonds rated between AAA and AA- fall in the same bucket (little haircut required).
The Moody’s downgrade doesn’t affect the role of US Treasuries in the financial plumbing world: banks still face 0% risk-weights when buying Treasuries, and the role of US bonds as the main collateral underlying the global repo market remains intact.
People will now try to compare the short-term bond market reaction to 2011, the last time when US Treasuries received a surprise and significant rating downgrade. Yet, the comparison makes no sense.
Remember that 10-year government bond yields can be decomposed as:
The downgrade can only directly impact the third component – term premium, which measures the compensation investors demand for various uncertainties attached to owning long-dated US Treasuries (generally growth and inflation volatility, but occasionally also other type of uncertainties).
We have shown how the downgrade doesn’t affect the role of US Treasuries in the global plumbing system, hence unless investors initiate a self-fulfilling fire-sale there shouldn’t be much impact from Moody’s action.
Yet, Moody’s is right on one thing: persistent primary deficits (3%+/year and growing) do require a different approach to bond markets than we had during the 2012-2019 period.
If you check the simple equation above, you will see that fiscal stimulus serves as a boost for cyclical growth which turns growth expectations higher – or alternatively, it limits the extent of economic weakness.
By constantly creating money for the private sector at a sustained pace, 3%+ primary deficits also contribute to stickier inflation – hence also affecting the second part of our equation.
The Fed still believes the neutral nominal rate (the rate at which the economy doesn’t cool off or overheats) sits at 3%, but it’s fair to assume that persistent fiscal deficits combined with a de-leveraged US private sector have pushed it higher. The bond market instead prices the US neutral rate at 3.50%, and it maintains a steep curve in the 10-30 year area as investor demand compensation to own long-end bonds.
Bonds are fairly priced here. I would start accumulating more 30-year Treasuries >5.25%.
If you invest in hedge funds or you’re involved in the HF industry: do you want to be on the distribution list of my macro hedge fund?
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2025-04-25 16:45:20
Hear, hear: the US Dollar is going down.
Investors love to attach an ex-post narrative to any price action, and this time the blame was on Trump’s erratic policies, the reduced attractiveness of US assets, and ‘’China dumping’’. Two of these actually make sense (you can easily guess which ones).
But there is a much bigger catalyst for the USD to sell-off more: FX hedging flows from proper ‘’whales’’.
These whales control $30 trillion (!) in USD-denominated assets, of which 13 trillion in equities and the remaining portion in fixed income instruments.
You may know these whales by their common names: GPIF, Norges Fund, CPPIB, APG, SuperAnnuation…
Foreign pension funds, insurance companies and asset managers are the true whales that could dump more US Dollars in an attempt to correct their sizeable and secular ‘’under-hedging’’ of USD risk:
In this article I will try to explain why these FX hedging flows (sell USD) could be triggered, quantify how big these flows could be, and assess which countries and currencies could represent the bulk of it.
The analytical process requires us to identify how big their USD asset pool is (in % of their domestic economy) and how much under-hedged they are.
But first – why do foreign whales actually ‘’under-hedge’’ their USD risk exposure?
Imagine you are the CPPIB – Canada’s biggest pension fund with $500bn+ in AuM.
You have to generate a consistent return of ~6-7% to be able to service your liabilities (future pensions), which means you’ll invest in a portfolio of stocks, bonds, real estate and alternatives.
Your liabilities are in CAD (as you’ll pay pensions to Canadians) but your assets can’t only be CAD-denominated because to satisfy your investment needs you’ll need to look into the US stock markets, $- denominated hedge funds, Treasuries etc. But by investing in USD-denominated assets, you are also implicitly getting exposure to USDCAD risk.
So – how much USD risk should you hedge? Or namely, how much USDCAD should you sell as a hedge?
The study above from Schroeders details the industry-standard approach: the top chart looks at the correlation between USDxxx (e.g. USDCAD) and your investment asset class (e.g. equities).
Recently, the USD has ‘’always’’ rallied when stocks sold-off as the world scrambled towards the safety of US assets backed by sound policymaking (= USD smile), and therefore being ‘’under-hedged’’ was great.
On top of it, given a currency like CAD (table below) is commodity/risk-on cyclical, during equity sell-offs having an active ‘’long’’ USDCAD exposure through under-hedging worked even better – and so the suggested USDCAD FX hedge ratio for a 60/40 portfolio is 40%.
But what happens when the USD does not rally (!) during risk-off environments, exactly as we are witnessing recently?
In that case, being under-hedged (= actively long USD) becomes painful as it compounds negatively alongside equities (and perhaps also bonds) losing value.
And that’s when these foreign whales would be forced to hedge, and kickstart a substantial USD firesale process.
Let’s dig into the data and find out:
A) How big these USD selling flows could be
B) Which currencies would be involved the most and why
The full macro research piece is available to the TMC institutional tier subscribers - a subscription costs several thousands of dollars per year.
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2025-03-31 14:31:37
Hi everyone - this is Alf, the CIO of my macro hedge fund Palinuro Capital.
I hope you're having a great day.
Before we start, do you want to be on the distribution list of my macro hedge fund?
Every two weeks, you will receive an update on the macro themes we are watching and the track record at Palinuro Capital.
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And now, to today's macro research piece.
‘’There are decades where nothing happens; and there are weeks where decades happen’’ – Vladimir Lenin.
Markets were sleepwalking into April 2nd before we had a decent sell-off in US stock markets on Friday.
But the size of the YTD sell-off (a mere 5%) masks a very interesting pattern happening below the surface.
For the first time since the first half of 2008, we are observing a rare macro pattern – almost a unicorn.
The S&P 500 and the US Dollar are going down at the same time:
The chart at page 1 shows the 3-month rolling returns for the US Dollar Index (DXY) and the S&P 500.
Historically, large SPX drawdown (left part of the scatter) tend to see the USD rallying heavily: the most convex USD appreciation (upper side of scatter) tends to coincide with bad equity drawdowns.
This also implies that the upper-left quadrant (SPX down a lot, USD up a lot) experiences the most elongated tail of all the quadrants.
The ‘’Macro Unicorn’’ bottom-left quadrant with SPX drawdowns happening alongside a weak USD is not very populated. It’s crucial to remember the last Macro Unicorn dot goes back to July 2008.
Why was it so hard for the USD to weaken while the S&P 500 was going down?
This is because of three reasons:
1) After 2008, the Eurodollar system blew up in size and never looked back;
2) The US aggressively swallowed global trade surpluses, and in exchange became the epicenter of all global financial flows into Treasuries and US stock markets;
3) Policymakers applied growth-friendly disinflationary policies and politicians postured towards defending Pax Americana on the geopolitical front
With such a combination of factors, the USD tends to appreciate during risk-off events.
A portion of the 12+ trillion dollars of USD debt issued by foreign entities has to be refinanced in any given year, and a risk-off environment which threatens to slow down global trade means all foreign entities rush to buy USDs to service their debt.
Foreign investors buy Treasuries because the Fed has your back and it will cut rates if financial conditions materially worsen – cross-border buying of US Treasuries strengthens the USD as money flows in the US.
The same foreign investors are reluctant to wind down their US equity exposures because Fed cuts will ultimately restore confidence.
Net-net, the USD goes up in risk-off events.
The only periods when the USD weakened alongside the SPX were 1998, 2002 and H1 2008.
These are all periods where US bubbles ended up deflating rapidly: think of the Dot Com bubble burst in 2001 or the US housing market crash of H1 2008 – before it turned into a global financial crisis.
These episodes all have one thing in common: a US idiosyncratic crisis.
And today, US policymakers seem to be doing all they can to generate one.
On the macro front, the US administration is injecting a large amount of uncertainty.
The ‘’no-visibility’’ approach from Trump on tariffs brings big unpredictability – and it’s also nearly impossible for US companies to plan capital expenditures and hiring given there is no visibility on tariffs.
To that business uncertainty, you need to sum up the leaked White House memo to the Washington Post (here) which aligns with the recent Musk interview highlighting a 25-35% cut to the federal workforce to achieve budget savings close to $1 trillion/year by the end of May.
Former Linkedin Chief Economist Guy Berger looks at a variety of high-frequency leading job market indicators, and I respect him as a non-biased non-alarmist economist.
He just produced the chart you see below:
Quoting him: ‘’The diffusion index of future headcount plans is now worse than it was immediately prior to the election. Additionally, and concerningly, that pessimism about the future is also affecting the present: the diffusion index of recent employment actions is trailing a year earlier by more than pre-election.’’
And this is before the Trump administration starts slashing ~800k federal employees.
To add to the potential ‘’Macro Unicorn’’ move which stems from a US idiosyncratic crisis, we are witnessing the very first signs of the unwind of the gigantic long US equity position held by foreign investors.
As shown by my friend Brent Donnelly, it is very rare to experience a month when the DAX is up while the SPX down – and we just experienced it:
If you take a step back, you realize that foreign investors have accumulated a gigantic amount of US securities since 2010. Trade surpluses came with a USD surplus for countries like Germany or Norway, which then recycled these excess USDs back into US Treasuries and US stock markets.
Canadian and Swiss investors own US securities to the tune of 100%+ of their GDP:
What if some of these foreign whales decide to reduce their exposure to US assets?
It would make sense given the new US geopolitical stance, the non-supportive policy mix (non-proactive Fed and tighter fiscal stance), business uncertainty from tariffs and still elevated valuations.
And what if markets get caught by surprise by a sudden change in correlations?
Exactly like in early 2022 when the correlation between bonds and stocks turned positive after 10+ years of persistently negative correlation as the Fed embarked in a hiking cycle that also hurt stock markets.
The Trump administration is trying to achieve an arduous trifecta: a weaker USD, lower yields, and a robust stock market.
Historically, to achieve this rare trifecta you need very disinflationary policies (yields and USD down) and a supportive Central Bank that boosts stock market sentiment.
The current policy mix of geopolitical shifts, tariffs and macro uncertainty risks achieving a weaker USD and lower yields but at the expense of the economy and the stock market.
After 17+ years of absence, the Macro Unicorn of simultaneously weak USD and weak US stock markets could stage an unexpected comeback.
Long-term macro investors should reduce their (implicit or explicit) exposure to the USD which has historically served well as a hedge against stock market drawdowns – if the Macro Unicorn appears again, a long USD long stock position could hurt twice.
If you are a hedge fund or a more active institutional investor, there are very interesting derivatives trades that can be structured to take advantage of the Macro Unicorn – text me (Alfonso Peccatiello) on Bloomberg and I’ll be happy to discuss.
Before you leave: do you want to be on the distribution list of my macro hedge fund?
Every two weeks, you will receive an update on the macro themes we are watching and the track record at Palinuro Capital.
To be added to the distribution list, click on the link below:
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2025-02-23 20:46:19
Hi everybody, Alf here - welcome back to The Macro Compass!
Before we go into today’s piece, a short announcement.
I advise several institutional investors on a bespoke basis.
Clients include Canadian pension funds, one of the biggest tech companies around, and top 3 multimanager hedge funds in the world.
Services go from sitting on the investment committee as an independent advisor, to constructing specific macro portfolios/hedging programs and consulting on a day-to-day basis (i.e. act as their independent macro analyst).
Are you are interested in my macro advisory services?
Please shoot an email with your request at: [email protected]
Fair warning: it’s not cheap, and it’s only for institutional investors.
Now, to the piece.
The first 5 weeks of the year have seen international equities outperforming the S&P 500: European and Chinese stocks have rallied harder than US stock indexes, and certain emerging markets like Chile or Poland are doing even better.
My main thesis for the first half of the year remains to be positioned with an ‘’International Risk Parity’’ portfolio: long US bonds, and long stocks around the world.
Let’s take a look at why.
The chart above shows that the US growth exceptionalism might be over.
The Aggregate Income Growth series is a great proxy for nominal growth in real time: it includes private sector job creation, workweek hours, and wage growth – effectively reflecting the growth rate of nominal income US workers are bringing home.
Today, it sits at 4.5% which is exactly the average level it recorded in 2014-2019.
These are the Goldilocks growth conditions and controlled inflation that international stocks enjoy.
Let’s now perform a data-driven analysis of what asset classes perform best during this prevailing macro conditions, and specifically when:
Core inflation is in the 1.75-2.25% range;
Real growth is in the ~1.50-2.50% range.
Here is what we found:
On a risk-adjusted basis, bonds do well - especially the long-end.
Stocks perform well too, with international stocks performing slightly better than US stocks: in our sample, European stocks pop up very often with CEE countries (higher beta like Romania or Hungary) leading the table.
To do well, international stocks need a combination of:
Goldilocks growth conditions (no US exceptionalism);
(On the way to be) controlled inflation and predictable Central Banks;
Reasonable valuations and a new narrative replacing the existing stale one.
Which brings us to the other required conditions: friendly developments in inflation coupled with a reasonable Central Bank, cheap valuations and a new narrative prevailing.
What are the best countries to look at today?
Let’s have a quick look at valuations:
The table above shows the forward P/E ratio for various international equity markets, and the most right column shows the 10-year percentile of valuations.
Broader European equities are still reasonably valued (Stoxx 600 more than Stoxx 50 which tends to give more focus to large cap German and French companies), but the standout country remains Poland.
Outside Europe, several countries in Asia and LatAm show cheap valuations.
Price-to-earnings ratios alone are not enough as a metric for valuations, and to broaden up the valuation assessment I like to look at Free Cash Flow Yield too.
FCF yield is the ratio between free cash flows and enterprise value, and you can think of it a measure of the amount of net cash genetated by the company and literally available to stock investors divided by the enterprise value.
The table below shows the 10-year percentile of FCF yield for different US and EU sectors, and different stock indexes around the world - the lowest the percentile, the cheaper the valuation:
If you consider valuations, policymaking and narratives my shortlist for international equity markets includes:
Developed markets: Europe, Japan, and Canada
Emerging markets: China and Mexico
Europe, Canada and Mexico were ‘‘priced to die’’ under the tariff threat, but as time goes by without much being done there investors are slowly realizing that inflation is under control and Central Banks are acting dovish. That supports stock markets.
In Japan, valuations are still broadly attractive because investors are growing nervous on how hawkish the BoJ will be - yet nominal growth is doing great (~5%+) and Ueda already verbally intervened to put a cap on bond yields.
Strong nominal growth and a cap on excessive tightening will benefit Japanese stocks.
Despite the big rally, Chinese stocks are still reasonably priced - the PBOC remains ready to ease, some fiscal spending is happening, and investors are largely underallocated.
In short: our analysis suggests that an ‘‘International Risk Parity’’ portfolio built with long US bonds and long international equity markets will perform well in H1 2025.
Thanks for reading!
If you enjoyed this piece, please share it with a friend:
Before you go, don’t forget this.
I advise several institutional investors on a bespoke basis.
Clients include Canadian pension funds, one of the biggest tech companies around, and top 3 multimanager hedge funds in the world.
Services go from sitting on the investment committee as an independent advisor, to constructing specific macro portfolios/hedging programs and consulting on a day-to-day basis (i.e. act as their independent macro analyst).
If you are interested in my macro advisory services, please shoot an email with your request at [email protected]
Fair warning: it’s not cheap, and it’s only for institutional investors.
2025-02-07 14:56:51
Hi everyone, Alf here - welcome back to The Macro Compass!
I am proud to announce that my macro hedge fund Palinuro Capital is live!
Do you want to be updated about the performance and progress of my hedge fund?
Sign up for free here:
And now, to the piece.
Our main macro thesis for the first half of 2025 is that another disinflationary wave will hit the US.
We expect core PCE to annualize at or below 2% in H1 2025.
Our Leading Inflation Indicator suggests we might be due for one last wave of disinflation in the first half of 2025:
To add some substance, this Leading Inflation Indicator is built using the 7 most statistically significant forward looking indicators for core US inflation.
The most recent dip is mostly attributable to leading indicators of shelter inflation, which represents 30%+ of the core US inflation baskets.
As you know, official shelter inflation tends to incorporate on-the-ground rent growth with a delay due to its methodology and series like the Zillow Rent Index have been used to predict where shelter inflation will go.
The CoreLogic single family rent index is one of the best predictor of shelter inflation, and it just printed at the lowest level in 14 years:
Some weakness in the housing market is starting to emerge - as evidenced by other leading indicators as well.
One of the main reasons why the housing market held up so well despite high mortgage rates was the gigantic backlog to work through.
During the pandemic, the demand for housing was super hot but supply bottlenecks and labor shortages lengthened the housing construction cycle - and this led to large backlogs which kept the housing market afloat.
Big US homebuilders like D.R. Horton are now reporting their backlogs have returned to 2019 levels, so this tailwind seems exhausted:
Additionally, yesterday's JOLTS report shows that the job openings for the construction sector are shrinking fast (see chart below).
The construction sector is key to the US business cycle, and cyclical weakening there has always been an early signal of a broader softening in US growth conditions.
Just to be clear: construction workers aren't getting laid off yet.
But it seems that the conditions are in place for a slowdown in the housing sector, which also leads to disinflation through the rent of shelter component:
Incoming data on inflation, growth and the housing market suggest a disinflationary slowdown in growth could be ahead of us. In that case, the Fed could quickly switch to a quarterly pace of cuts and reassert the Fed Put.
This ‘’proactive risk management’’ dovish stance would ease financial conditions = stocks and bonds rally:
Looking at the relative valuations across stocks and bond markets, the best risk/reward lies in fixed income.
At the moment, this is what the market is pricing the Fed to do over the next 2 years:
The Fed is priced to be on hold in March, deliver maybe 2 cuts in total this year, and pretty much stop there.
The terminal rate is priced around 3.90% - and that’s where the Fed cutting cycle stops.
Given the odds of Fed hikes are relatively small as long as Powell remains Fed Chair until May 2026, bonds offer an interesting risk/reward if my disinflationary thesis proves correct.
This was it for today, thanks for reading.
If you enjoyed the piece, please share it with a friend:
Finally, before you go…
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2025-01-19 15:59:21
Next week will be crucial for markets as Trump is set to announce (or disappointingly not announce) tariffs.
In this piece I will highlight the rationale behind my base case scenario and its impact on markets.
Before we do that, I want to share something with you.
I am offering a FREE trial to my institutional macro research service!
The service includes:
Multiple macro research pieces per week;
Timely coverage of important events and market implications;
Direct access to me
If you are a HNW private investor, a family office or an institutional investor feel free to request a free trial using the link below:
FREE Trial to Alf's Institutional Macro Research
And now, back to the article.
The biggest risk Trump runs with tariffs is a bond market insurrection: if investors perceive inflation as too high, tariffs can generate an injection of risk premium that launches bond yields to the moon.
In turn this would tighten financial conditions, slow down the economy, hamper Trump’s plans to reduce borrowing costs for the US, and just make him quite unpopular (people hate inflation spikes).
Luckily for him, the recently released inflation report suggests core PCE is trending at 2.3% - not bad:
Additionally, the latest job market report was encouraging and the control group of retail sales is running at 5.4% - around 2018 levels, when the pre-pandemic economy was considered strong. The economic momentum and a 2.3% trend in core PCE inflation provide Trump cover to go big on tariffs.
As the Fed hiked rates, all other Central Banks around the world merely followed the same strategy. The big issue here is that not all economies were equipped to handle such an abrupt increase in rates.
After the GFC, the US economy has deleveraged its private sector – private debt to GDP is down in the US. The US private sector also borrows mostly on fixed rate for long tenors (think about 30-year mortgages). The US also issues bonds in the global reserve currency, so bond vigilantes are unlikely to go after the US.
But what if another economy had high private sector debt, or upcoming refinancings, or floating rate mortgages and corporate borrowing which makes the passthrough of rate hikes fast and furious?
In that case, the economy will prove quite vulnerable to a prolonged hiking cycle.
The BIS just updated their private sector Debt Service Ratio (DSR) for H2 2024 – this snapshot allows us to verify in which countries households and corporates are under pressure from a prolonged hiking cycle.
Red or green colors refer to how much the DSR is above or below its long-term average in that country:
Notice how Canada and China are under increasing pressure.
And it would make sense for Trump to go after them – negotiating with a weak counterpart is always better. But identifying vulnerable economies is not only about the Debt Service Ratio – politics also matters.
For example, Germany is very unlevered as an economy: the German DNA prevents (for now) any proper deficit spending, and the private sector is also relatively conservative on how much it leverages.
As a consequence, the DSR doesn’t really pick up – yet the German economy is vulnerable.
Its business model of cheap energy imports and outsourcing production and manufacturing has been challenged by the pandemic, and China has made huge progress as a competitor for car exports. The German economy has taken a major hit, and people aren’t happy.
New elections are planned for February, and negotiating with a country in political turmoil is always better. From a game theory perspective Trump could decide to focus on China, Canada and Germany.
Even if Trump wants to target the most vulnerable economies, he must be careful.
Let’s take a look at the countries the US imports the most from, and in which categories of imports:
The car, pharma, oil and household/tech goods industries are by far the largest import sectors for the US. And Mexico, China, Canada and Germany the top 4 countries that exports the most volume to the US.
If Trump’s intention is to raise the most amount of money through tariffs on the most vulnerable economies, basic logic imposes equally heavy tariffs on all these 4 countries above.
But there is a risk in going huge against China from the get-go. While it’s very unlikely that Canada and Europe will protect their currencies, China could decide to do it.
And if we get 25%+ tariffs on China from the get-go but the CNY doesn’t weaken, US consumers will feel it. Higher import prices on Chinese goods without an offsetting move up in USDCNY = US consumers will take the hit out of Chinese tariffs, and not China.
Here, game theory would hence suggest Canada and Europe are the prime candidates for heavy tariffs.
Given that:
1) Soft inflation and solid growth provide cover for Trump to go aggressive on tariffs
2) To increase his negotiating power, Trump might focus on the most vulnerable economies
3) China, Canada and Europe are 3 vulnerable economies and the all export a ton to the US
4) But China can hit back via supporting the CNY = US consumers would pay for tariffs
5) Canada and Europe are not in a position to defend their FX, and they face political jitters
My base case for tariffs sees:
A global tariff rate of 10%
Additional targeted tariffs on China (phased-in monthly increase of 2.5% with no end in sight)
Additional targeted tariffs on Europe and Canada for a total of 25% to start (+ monthly increases)
If this unfolds, the market is not prepared.
Over the following 2-4 weeks, I would expect:
A) EURUSD to breach parity, and USDCAD to march towards 1.50
B) Bonds to rally at first, and stabilize after
C) An initial knee-jerk negative reaction in stock markets
If you liked this article, please share it with a friend.
And remember: I am offering a FREE trial to my institutional macro research service!
The service includes:
Multiple macro research pieces per week;
Timely coverage of important events and market implications;
Direct access to me
If you are a HNW private investor, a family office or an institutional investor feel free to request a free trial using the link below:
FREE Trial to Alf's Institutional Macro Research
Speak soon and have a wonderful day,
Alf