Asset Allocation Bi-Weekly – US Capital Flight and the Implications for Investors (May 5, 2025)

by Patrick Fearon-Hernandez, CFA | PDF

Oh, what a difference one calendar quarter can make! Shortly after Donald Trump was sworn in to his second term as president of the United States, we wrote that the US seemed to enjoy exceptional advantages versus the rest of the world in terms of its economic growth, political stability, and stock market returns. Other economists and market commentators echoed those views. However, just three months into Trump’s new term, many investors seem to be losing confidence in the US’s economic growth and management. As we discuss in this report, the evidence pointing in that direction includes a rise in the yields on US Treasury obligations, a depreciating dollar, and surging gold prices. Below, we discuss these trends and what they may mean for world financial markets going forward.

Reduced Bond Buying / Rising Bond Yields. As shown in the chart on the next page, the yield on the benchmark 10-year Treasury note stood at 4.57% on the first business day after Trump’s inauguration in January. Investors continued to scoop up Treasurys in the weeks following the ceremony, driven by expectations of slower economic growth, easing inflation pressures, and further interest rate cuts by the Federal Reserve. As the administration revealed more about its tariff plans and other aspects of economic policy, growing concerns about the US economy pushed 10-year Treasury yields as low as 4.01% in early April. Since then, however, Treasurys have sold off sharply. Importantly, it appears that foreign institutions in Japan and elsewhere have been a big part of the sell-off. In any case, 10-year Treasury yields have spiked to more than 4.40% since mid-April. The yield on 30-year Treasurys has spiked to as high as 4.91%.

A Depreciating Dollar. Just as US Treasurys have sold off, the dollar has depreciated against many key currencies. The chart below shows the Fed’s nominal US Dollar Index, which tracks the value of the greenback against a broad range of foreign currencies. The broad index shows the dollar has lost about 4.10% of its value since Inauguration Day, with an especially sharp drop since Trump announced the pause in his “reciprocal” tariffs on April 9. The dollar has especially fallen sharply against developed country currencies, such as the euro.

Rising Gold Prices. Rising bond yields and a falling dollar point to falling confidence in the US among global investors, so it should be no surprise that gold — the quintessential safe haven — has appreciated sharply. As shown in the next chart, gold prices have even reached a record high above $3,400 per ounce, with much of the increase coming since early April.

Of course, many long-term investors have been more focused on the recent volatility in US risk assets, especially stocks. In our view, the unique combination of market forces described above may be the more important underlying story. The rise in US bond yields, the decline in the dollar, and the surge in gold represent a rare alignment of market trends that may indicate some measure of capital flight from the US. This pattern of market moves suggests that global and even some domestic investors are trying to cut their exposure to US assets and the dollar. The likely culprit is the administration’s effort to rapidly and fundamentally change the US economic relationship with the rest of the world. As long as that endeavor continues, and investors are unsure of where the to-and-fro of policymaking will take them, these trends are likely to remain in place. Therefore, over the coming months and quarters, the most attractive assets may be much different than what we and other observers had expected at the start of the year. In particular, any continued US capital flight is likely to favor foreign equities, foreign currencies, and gold in the near term.

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Asset Allocation Bi-Weekly – Our Take on the Initial Trump Tariffs (February 18, 2025)

by the Asset Allocation Committee | PDF

While investors broadly understood that the new Trump administration would impose import tariffs as a key part of its economic policy, concrete details weren’t available until the initial tariff announcements on February 1. Even though some of those tariffs were quickly “paused,” the announcements gave us our first chance to explore how the administration intends to wield this weapon against other countries. This report provides our first take on the initial Trump tariff policies. As we show below, we think it’s still too early to gauge the impact that trade policy will have on inflation. What we can say is that the policies are likely to be disruptive for many sectors of the global economy, potentially prompting safe-haven buying in US Treasury obligations and precious metals.

In its February 1 announcement, the administration imposed 25% tariffs on most goods from Canada and Mexico, 10% tariffs on Canadian energy imports, and additional 10% tariffs on imports from China. For legal basis, the White House cited emergency economic authority based on fentanyl trafficking from those countries. Within about 48 hours, however, the administration announced a one-month pause in the tariffs against Canada and Mexico after those countries agreed to minor concessions, such as deploying more troops to their borders with the US to clamp down on illegal crossings and drug shipments. As of this writing, Beijing has made no concessions, so the tariffs on Chinese imports remain in place. At some point, the administration is also expected to impose tariffs against the European Union and potentially against multiple individual countries in Asia and beyond.

Mainstream economists tend to believe that import tariffs are inflationary, at least in the short term, because they can restrict the supply of goods to the domestic market. However, we don’t think investors should blindly assume that’s the case. For many reasons, tariffs may not put much upward pressure on prices. After all, some importers may have little market power and be unable to pass the cost of the tariffs onto their customers. In those cases, the importer would simply suffer lower profit margins. The threat of higher input prices might also discourage firms from investing, reducing overall demand in the economy and potentially offsetting price pressures. The impact on prices would likely differ across industries, depending on how quickly each industry can adjust to the tariffs. Therefore, much depends on whether the tariffs are applied broadly against all imports or targeted against specific trade partners and/or products. Finally, retaliation by the targeted trade partner has to be considered. For instance, countries hit with US tariffs might slap tariffs against US goods, thereby slowing down export growth, increasing domestic supply, and weighing on price pressures. The targeted countries might also impose retaliatory tariffs or embargos on their exports to the US, pushing up inflation.

Nevertheless, although it’s difficult to gauge the impact of tariffs or related trade barriers, the discussion above shows they can certainly be disruptive. Even the modest additional tariffs of 10% against the Chinese, which are already in place, will likely prompt reactions from businesses and consumers, and the net impact of those reactions remains unknowable. Beijing has also already retaliated by imposing tariffs on some US goods, preparing to curb shipments of certain minerals to the US, and ratcheting up regulatory scrutiny of US firms operating in China. For now, we think the main market reaction to the tariffs relates to the potential for economic disruption and uncertainty. In particular, it appears the tariffs have prompted investors to bid up safe-haven assets such as gold, silver, and longer-term bonds.

As shown in the chart below, the yield on 10-year US Treasury notes rose sharply to 4.65% over the first two days after President Trump was inaugurated, when investors were pleasantly surprised by the lack of any immediate tariff action despite the president’s earlier promises. Over the following two weeks, however, as the administration put more of its policies into place and investors could sense the possibility of economic disruptions, they bid up Treasurys, driving down yields. Once the Canadian, Mexican, and Chinese tariffs were announced at the start of February, the flight to safety intensified, pushing Treasury yields even lower to below 4.45%, although they have rebounded somewhat since then.

In the next chart, we show the progression of gold prices over the same period. Here, we see a pullback in gold prices in the period immediately after Trump’s inauguration, when his earliest executive orders and other policy announcements still seemed relatively tame to many investors, reducing the demand for safe-have assets. By early February, once the tariffs were announced, the general uptrend in gold prices re-accelerated, driving prices for the yellow metal to record highs above $2,900 per ounce.

As mentioned, it’s still too early to know whether Trump’s apparently neo-mercantilist economic policy and its associated tariff program will be inflationary. However, it does seem clear that investors are focused on the risk that the tariffs will drive prices higher and the potential for them to create economic disruptions. Investors are therefore bidding up traditional safe-haven assets, including longer-term Treasury obligations and gold. If and when the administration applies tariffs to the EU or other economies, we suspect longer-term Treasurys and gold could see another round of safe-haven buying. Based on technical analysis, we think the yield on the 10-year Treasury could be pushed down to its next major support level at about 4.17%, while gold could be pushed higher to its next expected resistance levels of $3,000 or $3,100 per ounce. Treasurys and gold could continue to be well bid until investors sense that the international trade environment has stabilized.

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Asset Allocation Bi-Weekly – Bonds and the Post-Election Environment (November 25, 2024)

by the Asset Allocation Committee | PDF

The election results are in and, contrary to expectations, voters rendered a quick and clear outcome, with Donald Trump set to return to the White House. The central case prior to the election was that the outcome would be drawn out and contentious — an outcome that would tend to support flight-to-safety assets, such as long-dated Treasurys. However, in the wake of the actual outcome, a reassessment is in order.

Our analysis of the long end of the yield curve starts with our yield model.

The model’s independent variables include the level of fed funds, the 15-year average of CPI yearly inflation, the five-year standard deviation of inflation, WTI oil prices, the yields on German and Japanese 10-year sovereign bonds, the yen/dollar exchange rate, the fiscal deficit scaled to GDP, and a binary variable for government control. As the model shows, yields are running below fair value but are within the expected range of outcomes.

As the election approached, despite the general consensus of a close race among the political pundits, the markets began to expect a GOP presidential win with a strong possibility of legislative control as well. In mid-September, the constant maturity 10-year T-note yield was 3.63%; it has increased to 4.45% in the wake of the election results.

A key issue is whether the yields will continue to rise in the coming weeks. Here are the factors we are watching:

  1. Our model’s government binary variable adds 30 bps to the fair value yield when there is a unified government. Since 1983, a situation where a single party controls both the executive and legislative branches usually results in greater spending and potentially higher deficits. We don’t apply that variable until the new legislature is seated, so we have not activated that variable quite yet. This variable will be in effect in January, though, which suggests there will be a bias toward higher yields.
  1. When yields peaked above 5% in late October 2023, the Treasury and the Federal Reserve acted in concert to bring yields lower. The Treasury adjusted its borrowing to the short end of the yield curve and Chair Powell signaled that the policy rate had peaked and was poised to decline. These actions sent yields lower to around 3.8% by late December 2023. Given that the current government is in “lame duck” status, we doubt that the Treasury will engage in similar behavior now. Thus, there will likely be greater tolerance for rising 10-year yields. In other words, although the Fed and the Treasury had signaled earlier that a 10-year yield above 5% was intolerable, that likely isn’t the case now.
  1. Since the recent FOMC decision to cut 25 bps, another similar cut at the mid-December meeting is mostly expected by the markets. The unknown is what future policy will look like in the wake of recent political developments. A model based on the difference between overall yearly CPI and unemployment (an approximation of the Phillips curve) would suggest that the current policy rate is near neutral.

Anything beyond the anticipated 50 bps of cuts before year’s end will begin to move monetary policy into easing mode, which will be difficult to justify without a rapid weakening of the labor market or a drop in inflation. Without further cuts, it will be difficult for long-term yields to decline significantly.

Once President-elect Trump assembles his team at the Treasury, we could see action similar to what occurred in October 2023 to bring down long-duration Treasury yields. However, until then, there is a window where yields could rise to uncomfortable (e.g., >5%) levels. Thus, we believe investors should exercise care in extending on the yield curve into next year.

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