It will lower the US growth rate and result in higher inflation and higher long-term interest rates in the US than might otherwise have been the case, which will – because of the importance of the US economy and markets to other economies and markets – have global effects.
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For the US, Trump’s massive tax cuts for wealthy Americans will greatly expand deficits and debt, but the expected revenue from his tariffs – several hundred billion dollars a year – would blunt the extent of the blow-outs.
An appeals court ruling last week that the core tariffs – his reciprocal and baseline tariffs – are illegal, however, has investors concerned that the revenue from those tariffs won’t materialise; that deficits and debt would be much larger; and even that much of the revenue raised so far, about $US142 billion, might have to be refunded. The administration has said it will lodge an appeal against that ruling, probably this week.
For investors in the US bond market – a market that influences bond prices and yields globally – there’s also Trump’s efforts to gain influence, and even control, within the Federal Reserve Board to force US short-term rates lower.
That includes at attempt to oust a governor, Lisa Cook, via untested social media allegation of fraud, which she is challenging in the courts this week.
If the Fed’s independence is compromised, or seen to be compromised, investors will demand a higher premium – higher yields – to compensate them for the increased risk of inflation that could flow from a central bank driven by short-term political advantage, rather than a considered view of how to achieve stable prices and a strong employment market in the longer term.
The uncertainty generated by Trump’s tariffs is already feeding into lower US growth, with data this week showing that factory activity last month contracted for the sixth successive month.
The bond market jitters have migrated to the sharemarket.Credit: Bloomberg
The case for a US rate cut at this month’s Fed meeting – a modest 25 basis points, not the three percentage points Trump has demanded – is strengthening. A jobs report on Friday could prove decisive if it shows the employment market is continuing to shrink.
The risk-aversion emerging in bond markets is starting to infect the sharemarket, which is highly sensitive to movements in longer-term bond yields, which are used to discount forecast cash flows to produce net present values for stocks.
This is particularly the case for the US market, where seven mega tech stocks – the “Magnificent Seven” – trading on huge multiples of their earnings, now account for about 34 per cent of the value of the entire S&P500. They are acutely sensitive to changes in discount rates.
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Nvidia, the world’s most valuable company, trades on a multiple of historic earnings of 50. The long-term average for the S&P500 is about 20 times earnings. Its share price fell 2 per cent on Tuesday, wiping $US83 billion off its market capitalisation. It has lost more than $US262 billion of market value since announcing its second-quarter result last week, when it provided a third-quarter forecast that disappointed investors.
The performance of the biggest tech stocks has masked the fact that the rest of the market has essentially traded sideways, even as market indices have been continually reaching record levels.
The market’s extreme concentration, driven by the companies’ massive investments in artificial intelligence, has increasingly generated references to past market bubbles, particularly the dot-com bubble, given the extraordinary scale of the returns required to validate the massive investments – $US3 trillion to $US4 trillion by the end of the decade – that the companies are making.
If there is a bubble, the combination of the market’s concentration and the inflated price-earnings multiples of the Magnificent Seven means relatively modest increases in longer-term bond yields could burst it.
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The global chaos and geopolitical tensions and shifts in relationships caused by Trump’s tariffs, their impact on corporate profits and consumer spending – they are a big new domestic consumption tax – and his overt efforts to grab control of the Fed, ought to have caused markets to freak out.
Apart from a brief bout of chaos after “Liberation Day” in April, when the reciprocal tariffs were first unveiled, the markets have been surprisingly calm, even ebullient, with the focus on AI and AI stocks overwhelming the usual influence of economic factors.
If long bond yields continue to rise and the spreads between short-term and long-term Treasury securities continues to widen, however, that might change, abruptly and convulsively, with repercussions well beyond the US.
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