Trump’s April 2 “Liberation Day” tariff announcement sparked sharp volatility in U.S. government debt and equity markets, with the S&P 500 index falling as much as 15% and borrowing costs rising.
Markets have stabilized after Trump suspended most of the retaliatory tariffs, but concerns remain that the president’s policy changes could dampen foreign investor enthusiasm for U.S. assets.
Equities in particular have outperformed global markets in recent years, prompting international investors to take large positions in them.
The Fairy Tale and the Dragon
What the above narrative says is that the US is no longer the investment destination of last resort, as the financial system has been shattered.
The story is well-known … as is the dragon – in the last 5 years alone, there have been inflows of $2.5 trillion into US assets (Treasury bonds, corporate bonds, stocks) and inflows of $1.3 trillion into US stocks alone. It should be noted that there were outflows from US stocks in the 2010s until the panic caused by the covid health crisis.
And while we’ve been inundated with stories of foreigners abandoning the safety of U.S. capital markets, the truth is—you guessed it—the opposite: namely, since Donald Trump’s “Liberation Day,” there’s very little evidence that investors are dumping U.S. assets (domestic institutions have sold $10.3 trillion, foreign institutions have bought $4.5 trillion), but the Fed’s Flow of Funds survey shows that foreign investors hold huge holdings in
- U.S. stocks worth $16 trillion (18% of the total),
- U.S. bonds worth $8.5 trillion (33% of the total),
- corporate bonds worth $4.4 trillion dollars (27% of the total), and
- long-term money moves slowly.
However, global capital is no longer exclusively chasing American assets, and a small reallocation of American stocks from 64% of global stock market capitalization ($49 trillion) to, say, 60% (average of the 2020s) would have a large positive impact on the rest of the world (note that American stocks have averaged well below 50% over the past 25 years).
There is no evidence, but we will find it
The willingness of international investors to acquire American assets “supports U.S. growth, supports job creation” and facilitates the government’s ability to finance the country’s large budget deficit and sell U.S. debt.
The CBO is working on a set of 10-year growth and fiscal projections, expected to be released this summer, that will provide the first comprehensive assessment of the Trump administration’s economic agenda at a time when concerns about the government’s finances abound.
The CBO head, balancing his approach, said he had yet to determine with certainty whether the sell-off of American assets and the dollar that was triggered by the April 2 tariffs would have a lasting impact, saying the hard evidence offered little indication so far.
“Will we see this as the turning point that really led to big changes in the global economy and a reduced role for the US? Or will it be an episode of instability that is overcome by other policies that improve growth [such as tax cuts and the government’s attempted deregulation of banks, businesses and investment] and more stability?” he said.
Since Trump’s Liberation Day and trade deals
The US this week reached its first agreement since Trump began his trade war, forging a deal with the UK, while talks with China are proceeding in good spirits (a deal is imminent) and Japan’s prime minister has announced a trade deal with the US.
But investors remained concerned about Washington’s ability to strike deals with other, larger trading partners. They are also waiting to see how the president’s other flagship policies, including calls for tax cuts and deregulation, will play out.
Taxation and deregulation will judge the budget
“It’s natural to think about tariffs given the volatility in April, but there are so many other aspects of the U.S. economy. It could stabilize the tariff part and then the government could make progress in other areas,” the CBO director said. That would be a positive outcome. Or we could look back and say this was the beginning of a period of slower growth.”
Swagel (CBO director) said that “part of the concern was that a reluctance among global investors to put capital into the U.S., or even just rebalance in a way that reduces their interest in U.S. securities, would affect the dollar.”
The sentiment among senior global finance officials—many of whom represent countries that hold significant dollar reserves—at this year’s spring meetings of the IMF and World Bank was “really as negative as I can remember.”
The Trump administration has acknowledged the “short-term pain” from the tariffs, but believes they are a price worth paying to bring manufacturing back home. It also trumpets the tariffs’ potential to raise revenue and reduce the federal deficit.
The Federal Budget Plan
Treasury Secretary Scott Bessent plans to halve the deficit from 6.4% in 2024 to 3% by the end of the president’s second term.
Swagel said it was “certainly possible” that the Treasury secretary would achieve his goal. “The combination of stronger growth and spending restraint could reduce the deficit. How much will depend on the details.”
The CBO is waiting for the passage of a key budget measure, known as a “reconciliation” bill, to assess the impact of the new administration’s policies before issuing its summer projections. Its previous projections, released in March, showed U.S. debt hitting a new post-World War II high later this decade.
The bill is set to include measures that would make permanent the tax cuts enacted during Trump’s first term — something the CBO has said would add $6 trillion to deficits over the next 10 years.
The CBO has said that a 10% general tariff would reduce deficits by $2.2 trillion over the next 10 years. But higher tariffs will not necessarily increase revenue by the same amount.
The stakes Donald Trump has placed are enormous and will determine developments not only in the United States but around the world.
