Successive administrations have repeatedly delayed the necessary changes, and short-term pain, required to get a grip on the public finances. Tariffs are one policy tool that could, if implemented correctly, help to repair the fiscal position of the US. A tighter fiscal policy need not necessarily be negative for stocks over the long run. By pushing down on US Treasury yields, sounder public finances can crowd in private investment, and lead to high-technology, high-productivity growth. Expansionary tax increases can work.
However, the overall arch of the current administration’s policies, as they currently stand, will add to, and exacerbate, the negative supply shocks set to buffet economies in the coming years, which are both negative for equities, and not that positive for bonds.
The Trump administration’s attempts to undermine the energy transition will ultimately work against US efforts to revitalise manufacturing and industry. The trade war will further dent progress on the clean energy transition, leaving global equities more exposed to both climate physical and transition risks, as climate change accelerates, and insurers pull coverage. Sweeping cuts to the IRS and climate & environment protection, are arguably the worst possible cuts, with the worst possible consequences for the deficit.
This is the real bear case for US equities: that the hit to GDP growth is accompanied by a further deterioration in the underlying fiscal situation (despite the stated intentions of the Trump administration) and that the policies pursued exacerbate the negative supply shocks set to hit the global economy (including climate change). Early on Saturday morning, the Senate passed a framework for a sweeping bill that would effectively permit $5.3tr in deficit-financed tax cuts (which would far outweigh any increase in revenues from tariffs). Repeated claims of fiscal responsibility appear are a red herring.
For equities, the prospect of ‘one big, beautiful bill’ being passed at some point this year may come as welcome relief. But even then, the bounce in equities may prove short-lived. The S&P 500 slid 9.1% last week. Treasury yields fell, but the moves were relatively muted, given the extent of the drop in equities. The 10-year Treasury yield fell 26 basis points to 4.01%. The 30-year Treasury yield was down 23 basis points to 4.41%, but real yields have stayed elevated, with the 30-year TIPS yield still at 2.28% as of Friday. [It is worth noting that the 30-year Treasury yield was flat this morning, despite another tumble in S&P 500 futures]. There is little doubt that the US economy will slow. The significant risk for equities, is that long bonds do not rally much, and in fact sell off, as foreign buyers begin to shy away from Treasuries in response to tariffs, and as investors begin to realise that there will not be progress on deficit reduction either.
