Talking Points

T-45 and still only the one 'deal' (with the UK). Trump loses patience with the EU; Japan, Korea, India still hoping for a deal soon. US Dollar still trades like an EM currency in APAC.

More Trump tariff threats in World Trade Week

Markets dominated data this past week as investors reacted to the difficulties Republicans were having passing President Trump’s One Big Beautiful Bill (yes, that’s its official name). By Thursday morning, the 10yr Treasury yield had risen 20bps since the previous Friday’s close and equities had shed 2%, falling back below the level at which they had started the year. Agreement on the budget reconciliation deal in the House of Congress brought some relief, but Trump’s threat on Friday morning of higher tariffs on the EU and tariffs specifically on Apple renewed concerns that investors had under-estimated Trump’s desire to raise tariffs. US equities ended the week 2.6% lower, while bond yields ended only 8bps higher than they’d been a week earlier.

It’s fitting that on Saturday, Trump declared the week just ending as “World Trade Week 2025”. The only trade-related development last week was the new tariff threats.

Indian Commerce and Industry Minister Goyal returned home after a second round of talks with US counterparts ended with some progress made but no agreement imminent. India continues to push for a permanent reduction in the US tariff to 10% (or lower) and removal of the extra tariffs on steel and aluminium. The government is reportedly threatening its own retaliatory tariffs if this doesn’t happen.

Japanese and South Korean delegations were also in Washington in recent days for talks but there have been no reports of new developments. Japanese PM Ishiba expressed some optimism a deal could be struck at the G7 meeting in Alberta in mid-June. Treasury Secretary Bessent said again yesterday that he expects to have “several large deals” announced in the next couple of weeks. We’ve heard that before.

Two things about recent bond market developments stand out to me. First, the spike in bond yields after Liberation Day (April 2) has been cited as the main factor leading to the decision on April 9 to suspend those ‘reciprocal’ tariffs and replace them with a flat 10% rate (except for China), which is lower for most countries than the tariffs announced on April 2. The ten-year bond yield rose to 4.46% on the morning of April 9, apparently prompting Trump to pull back on the tariffs. But yields have been above that level for most of the past two weeks and if anything the rhetoric from the US side has gotten tougher since the deal with China.

Perhaps instead it was the equity market that had been the deciding factor last month. US stocks had dropped more than 10% over two days following the April 2 announcement. Stocks have since regained all of those losses, and more, which may explain why Trump felt he could get away with threatening to raise the tariff on imports from Europe to 50% — double the April 2 tariff rate — and imposing an unspecified tariff on Apple in retaliation for their decision to move US-bound iPhone production from China to India. As I’ve warned repeatedly, Trump wants manufacturing to move from China to the US, not to third countries.

It may seem nit-picking to ask whether Trump is more sensitive to rising bond yields or falling equities, but understanding what might motivate him to back off is important for understanding the fate of his tariff policies. Put simply, equity markets do not appear to be pricing in an increase in tariffs after July 9. But if Trump will be motivated to stop raising tariffs only if the equity market sells off by 10% or more then investors have a time inconsistency problem. Equity valuations today are not consistent with this view of how Trump sees the trade-off between tariffs and stocks.

Second, the bond market quite clearly sees the net effect of tariffs on the US economy as deflationary while surveys show that US households see tariffs as likely to be very inflationary. Ultimately, it’ll be an empirical question: tariffs work by raising prices on imports, which is inflationary especially if US competitors also raise their prices. But if the tariff reduces demand for imports but doesn’t increase demand for US-made goods, economic activity could be so depressed that prices of domestic goods fall, leading to less inflation.

I noted last week that while it was probably too soon to see tariffs reflected in consumer prices in April, the import price indexes showed only marginal declines in import prices from China since tariffs were raised in February and higher prices on imports from ASEAN and the Asian NICs. This means that US importers paying tariffs in April were not getting much relief at all from lower prices charged by Chinese suppliers. Meanwhile the rate of inflation on domestic goods and services in the US slowed.

The 10yr breakeven inflation rate at the end of this past week was precisely its April 1 value. The real yield has increased 34bps — not because investors are more optimistic on the outlook for growth but because they’re more worried about the fiscal outlook.

On Friday, when Trump tweeted his new tariff threats, breakeven inflation rates fell slightly, another sign that markets see higher tariffs as deflationary. If investors are wrong and households are right — and inflation surprises significantly to the upside — markets are in for a rough time. Investors are not positioned for an inflation shock.

In the near-term, though, political risk is probably the greater worry. If the Senate doesn’t pass the OBBB fears of fiscal instability and default risk will rise anew.

APAC currencies strengthen despite rising US yields

In APAC, bond yields were generally much less volatile than in the US. And by the end of the week most countries had seen yields fall relative to Treasuries. Indeed, yields in Indonesia, India, Australia, Malaysia and Thailand declined last week, while yields in Vietnam, Taiwan, Singapore, China, New Zealand and South Korea rose, but less than in the US. Only Hong Kong and the Philippines saw yields rise more than in the US.

And yet most APAC currencies strengthened against the dollar last week. I first alerted you to this unusual pattern in early April when US bond yields spiked up but the dollar weakened. To show how unusual this is, I plot below a simple average of exchange rate indices for ten Asian emerging market currencies (CNY, INR, IDR, MYR, PHP, SGD, KRW, TWD, THB and VND) against the average differential between the US 10yr yield and these same economies’ 10yr yields.

Normally, higher USD yields relative to Asian yields leads to weaker Asian currencies (a rise in this index, which is expressed as the number of local currency units per dollar). This had been, in fact, the best way to understand fluctuations in the CNY and JPY since the pandemic. But look what happened in early April. Immediately after Liberation Day, US yields fell and Asian currencies strengthened as you’d expect. Then after a couple of days both reversed. But after April 9, higher relative yields in the US have not been associated with weaker Asian currencies. In fact, most Asian currencies have strengthened over the past few weeks while US yields have risen relatively quickly.

So it was that last week almost all APAC currencies appreciated against the dollar even while US yields rose relative to most APAC yields. On average, APAC currencies gained more than 1% last week — the JPY, KRW and THB rose more than 2% against the dollar. It’s tempting to conclude that the combination of a damaging tariff policy and failure to meet expectations for fiscal consolidation is pushing capital out of the US, driving yields up and the currency down.

We see the same relative underperformance in equity markets recently too. US stocks lost 2.6% last week after rising 17% since the suspension of the highest April 2 tariffs. Stocks in Australia and in the Asia-ex Japan group (in USD) had risen slightly more than US stocks since April 8 and fell much less than US stocks last week. Stocks in Japan haven’t done quite so well as US stocks.

We had three APAC central banks cut rates last week and an update on inflation in Japan.