In this short video, Phil Milburn discusses the impact of Trump’s tariffs on markets and central banks and why this could be a good time to invest in bonds
Phil Milburn: The US's self-proclaimed Liberation Day has now been and gone. Despite being well-flagged, the tariffs were even higher than expected, causing some shock and awe in the markets. This is a reiteration of what we've seen over the last few months, of policy uncertainty being very high. We now have the first bit of certainty of where tariffs could be, but we now have to watch out for retaliatory measures, then counter measures again from the States. Treasury Secretary Bessent has said this will be the highs in the tariffs and can be negotiated down, but that is provided there are no countermeasures from anybody that have had tariffs inflicted on them. But let's take a look at policy uncertainty. A well-used chart this year, you can see how elevated it is compared to the last 10 years of history, with only really high uncertainty during the Covid times for obvious reasons. I find it more informative to actually introduce some market measure here, so I've actually added the VIX volatility index to the chart. We've obviously not seen the spike we saw during Covid, but we've still seen a big increase in market volatility due to that level uncertainty. Now, where do we go from here? There's a lot to be determined still with the countermeasures, but the initial calculations show that this should knock about 1% to 1.5% off US GDP this year, and have a similar impact on the upside to inflation, leaving nominal GDP about the same.
Phil [00:03:01] For the rest of the world, there's a similar stagflationary impulse but taking longer term, this is clearly bad for longer term growth, and the question is whether the inflation impulse is temporary or permanent. Certainly the real potential growth around the world if these tariffs all stick, will be much lower. But in my opinion [this is just a supply shock and most, not all, but most of the inflation will be felt over the next year or two. The problem is here that central banks, including the Fed, have made a mistake a few years ago referring to inflation as transitory when it lasted a lot longer and was much higher. Now as we look at it, the central banks will want to continue to regain their credibility, and so they will keep rates higher and monetary policy tighter for longer than necessary. I believe the Fed will want to make sure there are no second order impacts of the ramp up in goods prices passing through to services inflation. The transmission mechanism for that is through the labour market, and the US labour market is slowly softening, even before the impact of any DOGE cuts. So the Fed will cut, but it will take them a while longer as they can afford to wait and spend the time to make sure that that second order inflation impact isn't happening. The markets are already looking more at growth than inflation and we've seen short-dated inflation break-evens this year widen, meaning the market is saying there will be more inflation in the next year or two, but longer-dated inflation measures have been much more well behaved. Tiny bit of bond geekery; the 5-year, 5-year forward inflation swap has actually come down from a peak this year of about 265 to now about 240 basis points, 2.4%. The market's saying, 'okay, yes, there will be more inflation shorter term, but longer term inflation remains well behaved'. In the meantime real yields continue to fall in the market because the market is saying this will impact and create growth. What this means for our strategies, is we think it's still a great time to be owning bonds, to be owning government bond risk, interest rate risk, so we want to be long duration but still leave some room to add as there will be continue to be heightened uncertainty. On the flip side with heightened volatility, we have seen some credit spread widening. We've taken that opportunity to do some rotation within the Funds, being nimble throughout this, moving in banks more into lower tier two, but not reaching into additional tier one yet. And in high yield, there's been a big movement in relative value between European high yield, which is outperformed US high yield and we're actively rotating out of European high yield into the cheaper, on a spread basis and yield basis, dollar markets. So there's volatility and the tariffs might be unwelcome, but the volatility is very welcome as there's a chance to add value for the portfolio's strategies.
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