�۶���Ƶ

April has been a month of extremes, but it is in extreme scenarios that we are learning what limitations Trump faces in his bid to reshape the US domestically, and in its relationship with the rest of the world. We think these constraints provide the market with some reassurance that the most negative tail-scenarios can be avoided, even though the economic outlook is set to deteriorate in coming months.

The bond market has been a preeminent constraint on Trump, offering an immediate and unbiased assessment on his policy proposals. When the Treasury curve bear steepens – driven by long-end bond yields rising, US equities falling, and the USD weakening, all together – it is a sign that markets are rejecting the direction of US policy.

A disorderly rise in long-end bond yields is disconcerting as it raises government refinancing costs, leads to higher borrowing rates for US households and businesses, and shakes investor confidence in the traditional hedging properties of US Treasuries. This confidence is vital for market health, as US Treasuries are the basis for the discount rate for global assets and act as key collateral for the global financial system.

On two occasions, we have seen policy U-turns following sharp rises in long-end yields. First on April 9, Trump postponed reciprocal tariffs by 90-days, acknowledging on the same day that “the bond market is very tricky.” Second, on April 22, Trump made it clear that he had no intention to fire Fed Chairman Powell. These episodes restored Treasury market function and reassured us that there are constraints on Trump, making worst case outcomes related to tariffs and the Fed chair less likely.

Exhibit 1: Rises in long-end yields have preceded policy U-turns

The US 30-year yield

Another constraint on Trump is the political economy. While Trump does see his re-election as an opportunity to reshape the global trade landscape and re-shore manufacturing, his agenda is not immune from serious near-term economic and political concerns. Trump’s support among Republicans has been resilient, but cracks are starting to form, and this is before tariffs have started to meaningfully impact the economy.

Respondents of the NFIB small business optimism survey viewed Trump as a strong positive for the economy both times he was elected, which implies a Republican lean among those surveyed. In 2016, the election optimism was sustained through Trump’s first-term until the outbreak of COVID-19. This time, optimism has already turned lower in response to Trump’s policies, with an eleven percentage point drop in the number of respondents who view the economic outlook as positive for the next three months.

Exhibit 2: Small business owners are turning negative on the economy

NFIB Small Business Optimism Index

Many small businesses are particularly vulnerable to the US-China tariffs. Thousands depend on imports from China and do not have the margin space to pay 145% tariffs, nor the flexibility to immediately shift their supply chains overnight. With US-China shipments collapsing under the weight of the tariffs and inventories running low, thousands of small businesses may be forced to close and lay-off workers. Small businesses, or companies with less than 500 employees, make up more than 80 percent of US private employment.

Based on pre-election polls, the most important issues to voters were the cost of living and overall health of the economy (along with immigration). If Trump’s tariffs are sustained, �۶���Ƶ economists project monthly core inflation prints to start annualizing above 7 percent in the late summer months. With CEOs from Walmart, Target and Home Depot warning the President there could start to be ‘empty shelves’ within weeks, it’s no wonder he and Scott Bessent have called the tariffs ‘unsustainable’ and used de-escalatory language. With China in no apparent rush to negotiate, President Trump will likely face a very uncomfortable economic and presumably political environment unless he scales back on tariffs meaningfully. We think he will.

Exhibit 3: Voters care about inflation. They don’t care about tariffs.

US opinion poll most important issues

Even if President Trump scales back tariffs dramatically, it is clear the US economy still faces a sharp slowdown. Business sentiment has collapsed, suggesting that investment is likely to be curtailed. Real incomes are slowing, which will weigh on consumption. And mortgage rates remain too high for the housing market.

For markets, how does one square an anticipated de-escalation of trade policy with an imminent slowdown in the economy? Can risk assets ‘look through’ a few quarters of weaker growth and earnings if the direction of travel is towards less damaging economic policies?

We feel comfortable saying that the anticipated shift in policies will be enough to avoid worst case market outcomes. At the same time, markets don’t seem to be pricing much deterioration in earnings and multiples associated with impending downside risks to the economy, particularly in an environment where monetary policy may be constrained due to elevated inflation and fiscal space is limited.

So we expect risk assets to be choppy in a wide range, and prefer relative value positions to big directional bets, especially in an environment when markets can be turned on their head by a tweet. We will look to fade sentiment extremes in either direction.

As the economy slows, we favor exposure to the quality factor, both inside and outside the US. We also like high quality bonds, particularly outside the US and closer to the five year point of the curve. In foreign exchange, we see room for further USD weakness over the course of the year, as global portfolios look to scale back on exposures that have become heavily weighted towards the US. Despite its sharp gains, gold remains a helpful diversifier for stagflationary economic outcomes and broader policy uncertainty.

Asset class views