Trade wars – Escalation mode
Global trade wars took an escalatory turn last week. The US government raised tariff rates on Chinese imports to 145%, and China matched the increase, bringing its rate on US imports to 125%. Some carve-outs for electronic hardware were announced over the weekend. Furthermore, reciprocal tariffs excluding China were postponed for 90 days, during which a 10% rate will prevail. The overall US tariff rate is still hovering north of 20%, at current policies. Trade restrictions between US and China makes any trade virtually impossible and should therefore been as a first step of a more holistic negotiation over their economic relationship. We expect steps to be made in this direction, but not necessarily very quickly. Our base case is for a global slowdown, led by the US. Recent estimates suggest a 0.5-1% cost to 2025 global growth stemming from the recent dispute, although a final projection requires a stable policy arrangement. Both a prolonged trade war and lingering uncertainty provide downside risks to any forecast and open recession risk.
Markets – Tectonic shifts
The trade escalation turned into the most volatile week in markets since 2008. The VIX spent much of the week between 50 and 60, a historically high level. US equities fell sharply on Monday, to recovered on Wednesday on the reciprocal tariff reductions and rally 10% in one day. Thursday and Friday weakness resumed. US high-yield (HY) spreads moved to levels shy of 500 basis points, and Investment Grade (IG) spreads just shy of 90. European and Asian markets followed the move, with a lesser factor. Risk assets are now pricing in a fair chance of recession, although not fully. Recessions typically see equity multiples and credit spreads at more critical levels. Rapidity has been starker than the levels reached, likely due to extreme de-risking from leveraged and long-only investors. We believe some value has been created in high quality credit but believe that markets will overall remain volatile, and some downside is still present.
Fixed income – US risk premia on the rise
Last week, US equities, long-end treasury and the Dollar exhibited a stark positive correlation. EUR/USD liaised with 1.14, the highest level since early 2022. US 30-year bonds are just shy of 5%, and most of the move driven by real rates, as breakevens fell sharply. US long-end real yields are close to all-time highs, and trade 85 basis points above comparable swap rates. In other words, the market is requiring a credit premium to US assets. Part of this move is purely technical, as recent developments are triggering some repatriation from inflated US assets. Still, it is an important alarm bell for the administration and the Federal Reserve. Overall, a full “BTP-like” narrative for US Treasuries is unlikely to persist, given the intrinsic strength of the underlying macro and market depth. More uncertainty will nonetheless mean less natural hedging from the currency and the bond market. We do not expect the Fed to intervene immediately to stabilise the situation, but more disorderly price action would call for at least verbal warnings.
ECB – Dovish turn on the horizon
On Thursday, the ECB will hold its monetary policy meeting. The Eurozone macro-outlook is significantly weaker and more uncertain than it was at the March meeting. Tariffs will hit the continent with a minimum 10% rate, inflation pressures from the new trade policy are on the downside, and the Euro is unexpectedly strong. The developments are likely to twist the balance of risk heavily on the dovish side. The March projections remained quite optimistic on growth, and ECB models factor in a weaker currency as a result of tariffs, at odds with reality in markets. We expect the ECB to cut 25 basis points but see the risks of a marked change in forward guidance.
Algebris Investments’ Global Credit Team
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