Dear Investor

General Market Overview

Multiple trade tariff announcements by various countries have been driving equity market sentiment since April, resulting in increased market volatility. On the 2nd of April, United States (US) President Trump’s announcement of a 10% minimum tariff on nearly all US imports, effective the 5th of April, led to a sharp decline in stock futures. This move in the futures market triggered a chain reaction, with the S&P 500 losing 6.65% on the 3rd of April, marking the worst selloff since the COVID-19 pandemic. By the 7th of April, the S&P 500 had fallen over 10% in the prior two trading sessions, a decline comparable to historic crashes like those in 1987 and 2008.

However, on the 9th of April, the US announced a 90-day pause on higher “reciprocal” tariffs (above the 10% baseline) for most countries, except China, effective immediately, which generated a sharp rebound in share prices. Tariffs on Chinese exports were raised to 125% in response to China’s 84% retaliatory tariffs on US goods. A month later, tariffs on Chinese goods were paused/lowered (9th of May) for 30 days, indicating something of a de-escalation between the US and China.

While US-China trade tensions may have eased, on the 23rd of May, a 50% tariff on all European Union (EU) imports was announced in response to “stalled trade negotiations and unfair EU trade practices.” And then, on the 31st of May, President Trump posted: “It’s my great honour to raise tariffs on both steel and aluminium from 25% to 50% effective Wednesday 4th of June.” The objective of this tariff is to promote and protect the US steel and aluminium industries.

The continuous stream of tariff announcements is responsible for what has been described as “fast-moving chaos” in international markets.

Also notable in the US, in a “first time in history” event, all three credit rating agencies, Moody’s, S&P and Fitch, have downgraded the US credit rating. The latest downgrade from Moody’s cites concerns over soaring US debt levels, with interest on US debt set to hit 30% of revenue by 2035.

In 2011, S&P downgraded the US credit rating from AAA to AA+ and in 2023, Fitch downgraded the US long-term credit rating from AAA to AA+. Many have dismissed Moody’s downgrade as unimportant, primarily arguing that global investors will continue to borrow from the US, regardless of the ratings. 

However, US government debt as a percentage of Gross Domestic Product (GDP) is currently 124% of US nominal GDP, having reached an all-time high of 130% in early 2021. The high debt levels mean that the US net interest payment to GDP is 4.6%. This measure is a key indicator of a country’s fiscal burden and its ability to manage debt without compromising other budgetary priorities.

Factors that have led to this high interest rate burden are, of course, high levels of government debt and higher interest rates. Initially, the rise in yields following the COVID-19 pandemic was driven by improving growth and some rising inflation; US real GDP growth rebounded to 5.9% in 2021. This strong growth and spiking inflation (9.1% year-over-year (y/y) in June 2022) signalled higher future demand and economic activity, pushing yields up as investors anticipated tighter monetary policy to prevent overheating. However, over the last 24 months, monetary concerns have become a much bigger driver of rising yields than economic ones.

US inflation is 2.3% y/y, and the annual GDP growth rate is 2.1%, a different economic profile from the post-COVID rebound. The US Federal Reserve (the Fed) has started reducing interest rates, but the actions and guidance have been cautious. Given lower inflation and lower economic growth, it would be expected that US 10-year yields should not have remained high.

It is now feared that higher interest rates will require more government debt to service already issued debt, leading to a circular loop, and hence, monetary concerns are pushing yields higher.

Higher yields are not just being seen in the US but across many developed markets. Germany, the United Kingdom (UK), Australia, and, of course, Japan are all experiencing higher government bond yields. This market dynamic is likely to result in currency devaluation, creating a case for hard assets and some equities over material exposure to fixed income. Interestingly, companies like Apple, with huge “piles of cash” on their balance sheet, may be seen as a safer or more attractive “fixed income” vehicle than government debt itself.

General Conclusion

This quarter has been underscored by global equity market volatility driven by escalating trade tensions. The sharp selloff in early April served as a reminder of how policy shocks can ripple across global equity markets. Coupled with international trade concerns are increasing monetary concerns about rising levels of global government debt, prompting a changing sentiment about creditworthiness and leading to higher fixed income yields.

There is a delicate balance between international relations and global fiscal and monetary policy, as well as how global central banks intend to act, given the trade-tariff inflationary potential versus the risk of lower economic growth. As such, the outlook for international markets is currently uncertain, and our investment positions are being closely monitored in light of this uncertainty.