Macro investing insights

JACK JANASIEWICZ: My name is Jack Janasiewicz, Lead Portfolio Strategist and one of the portfolio managers on the Natixis Investment Managers solution funds.

BRIAN HESS: And I'm Brian Hess, Investment Strategist. This is Tactical Take. Well, Jack, I guess this is going to be our tariff episode.

JACK JANASIEWICZ: [CHUCKLES] Shocker.

BRIAN HESS: It's mid-April, mid-month. We've had a very volatile start to the month. We're in a bit of a period of quiet. So maybe it's a good time for us to reflect on what's happened, take stock of the year, and think about paths forward.

And so I thought we could start by highlighting that we had turned defensive even before the tariff announcements, even before Liberation Day. We had gone underweight equities in our models for the first time since 2020. Just remind everyone what we were looking at and seeing in the first quarter to already set us down a path toward some caution.

JACK JANASIEWICZ: Yeah. And that's actually, I think, a very important point to highlight here because our idea was that the market would be reflecting the potential of a growth slowdown. And that's what we were starting to see. We've highlighted this over and over again. But defense spending, for example-- huge contributor to GDP growth-- that was probably going to need to come off the boil a bit.

Looking at things like state and local government spending, which I think had really been bumped up coming out of COVID, a lot of that excess money was basically spent. You're actually now looking at state and local government spending as potentially being a drag going forward.

The bigger one here-- interest rates not really moving, mortgage rates not moving. So you're sort of in this freeze with the housing market and residential construction. Very, very big important generator for growth in the US economy.

And then the last one, the labor market cooling-- nominal incomes coming down, real incomes coming down. So we expected to see consumption slowing at the margins. So put all of these things together, and we were expecting growth to slow and potentially the market overextrapolating that into something worse than that.

BRIAN HESS: So we had something like 10 quarters in a row of really good growth, averaging high twos, 3% real GDP growth. And at the start of this year, unfortunately, a lot of those drivers started to go in reverse. So really the two big drivers-- it was consumer, and it was government spending. And they were cooling while the other areas of the economy couldn't pick up the slack.

So we had a setup where the economy was already a little bit vulnerable to an external shock. And then, of course, we get the Liberation Day announcement. And that was quite a shock, actually. And so what was your initial reaction on that day to the first round of reciprocal tariffs, where we just went down the line on every country with some really high rates?

JACK JANASIEWICZ: And I think the expectations going in were for some tariffs to be set across the board. But those really being set up for a negotiation entice countries to come to the table and cut some trade deals, China probably being an exception there being a little bit more punitive.

And what we got was something much broader and much more, I think, harsher than we were expecting. And, obviously, the market reacted accordingly. So I think that threw everybody's base case scenario off here. And people then started to question whether we were really going to be using tariffs as a negotiating tool or if there was something bigger. 

And that has some pretty significant ramifications, because things we could be thinking about-- reordering global trade or just a revenue raiser-- those things mean tariffs stay on for longer than, I think, people were anticipating, whereas if you're of the view that tariffs were going to be a negotiation tool, a good chance that those come down or even come off in the near term.

BRIAN HESS: So a lot of the assumptions behind the tariffs were called into question after that announcement.

JACK JANASIEWICZ: It's an understatement, to say the least.

BRIAN HESS: And when we were turning cautious earlier in the year, we were thinking slowdown but not really talking recession at all. We felt like there was enough growth momentum that we could slow and still be in a safe place.

If those tariff rates that were announced on Liberation Day were to go into effect, do you think that would push us into recession?

JACK JANASIEWICZ: It would certainly put the odds well more than—

BRIAN HESS: I mean, it seems pretty likely. Right?

JACK JANASIEWICZ: Yeah, well north of 50/50. Definitely that's the case.

BRIAN HESS: OK. Yeah. But what we've gotten since then has been this 90-day freeze, where for most countries the tariffs are on hold, we've got the 10% baseline. But that's a level that is not too disruptive to the economy.

However, China still subject to what is now a 145% tariff rate. So how does this-- I guess first question is you talked about the underlying motivations behind the tariffs-- how does this change our thinking about those motivations? Does it shed light on what the administration is really after?

JACK JANASIEWICZ: I think there's still plenty of uncertainty here going forward. And I think that's going to complicate the backdrop. So when we still think about the economic path going forward, you've introduced, I think, a significant bout of credibility concerns with the Trump administration. And that, I think, is going to probably hang over the market for quite some time.

If we compare where we're at today relative to where we thought we were going to be pre-Liberation Day, you have some of that same backdrop. Right? Tariffs are kind of back to some broader, more normal level that is negotiable, maybe a little bit harsher on the China backdrop. But now you're introducing that uncertainty, that-- how reliable can we look at the policy going forward from the Trump administration? And that is certainly damaging credibility going forward, which damages confidence. And that's a big one for markets when you start talking about risk-taking.

So it resets, but all of a sudden you're starting from a very different perspective. And that really comes down to that credibility. And that's a big one in here.

BRIAN HESS: We've seen consumer confidence really take a dive. It was already quite weak heading into the tariff announcement. But it just continues to plunge. We've seen business confidence take a hit, to your point.

So the problem is weak consumer confidence is going to hold back spending. It's not a great time to make that big-ticket purchase maybe. Business confidence is going to hold back investment. Not a lot of clarity on what's likely to happen on the policy front. And these are things that are important for allowing the economy to expand. So I think that's the negative situation.

A positive light you can maybe cast on it would be that with the tariffs so focused on China for the time being, it may be-- in my mind, it discounts the idea that they're using tariffs as a revenue tool because I don't think we can count on countries continuing to-- or us continuing to buy imports from China at that tariff rate. There's going to be things moving around. We'll source from elsewhere.

So maybe it is more about really dealing with the trade deficit, which the Trump administration doesn't like-- it's quite big-- and also enhancing national security, which means that there's reason for optimism, I think, in some regard.

So with that said, and understanding that we still have a lot of work to do in terms of bilateral negotiations with the countries away from China, how comfortable are you with the idea that maybe we've seen the worst in markets and there's not a lot of incremental downside?

JACK JANASIEWICZ: Yeah. And I think that's one of the ways that we're thinking about it. We've described this backdrop in terms of that probability-weighted distribution outcome-- that histogram, so to speak.

And we talk in terms of tails, right? The right tail is going to be the potential upside. The left tail is going to be the potential downside. And I think going into this, that left tail was a huge uncertainty. So we would describe that as maybe a fat tail that kind of had a long length to it. You just didn't know.

But now all of a sudden, we could call this maybe peak tariffs, if you will. And so maybe we have a glimpse at how draconian these could be. And that, I think, helps us to maybe quantify that left tail risk a lot more.

So the idea there is that, OK, instead of being sort of long and fat, now the tail has been shrunk a little bit, maybe not as wide. And we know where that Trump put is, so to speak. And that gives us, I think, a better idea of what the potential downside could look like. 

And as a result, it gives you a better chance to frame out what the risk-reward opportunities are. So if we call peak tariffs that worst-case scenario-- the S&P had gotten down to almost 5,000, a little below that intraday-- maybe that's the worst-case scenario. And you can reframe your risk-reward perspectives based on that worst-case scenario.

BRIAN HESS: So the uncertainty probably acts as a lid on asset prices for the time being. It will make it hard for us to have a V-shaped bottom and retrace back to the highs.

JACK JANASIEWICZ: So looking at it from both perspectives, we just talked a little bit about that left tail risk. The right tail probably is still clipped as well just because of that uncertainty, the lack of confidence going forward. And it takes a long time for that confidence to heal.

So we'd be hard pressed to see the market ripping back up to the upside into what you just said, that V-shaped recovery here. So maybe, if anything, we've got a range trade where it's sell the rip, buy the dip, and we muddle through that for a couple of months until we get a little bit more confidence in trade policy going forward.

BRIAN HESS: Yeah. So we're going to look for maybe high volatility but ultimately a trading range for the markets while the White House tries to negotiate with key trading partners on tariffs. So we got to talk to the European Union. That's going to be a big one. We've got to work with Canada, and hopefully there's some progress on the China announcement as well or on those 145% tariffs, which is really quite a punitive rate. 

Now, one of the interesting market reactions happened in the Treasury market where, similar to 2022, treasuries did not provide much ballast as stocks were dropping. What do you think happened there? And what's the story with bonds?

JACK JANASIEWICZ: Yeah. We've heard quite a few different ideas that have been posited out there to explain what's going on with the Treasury market. One of them was that the Chinese were selling. That's something I think that it's a pretty easy fallback whenever there's market volatility. And it happens to be that it's an issue between the US and geopolitical risk between the US and China.

It's always, well, the Chinese are selling treasuries to push the Treasury market weaker. I'm not sold on that one. I'm a little bit questioning that. I think more so what we're seeing is really a function of deleveraging, de-risking, in the marketplace. And there's a couple of things you could point to there.

One, you could look at the move that we had seen in the yen relative to treasuries. You had the yen carry trade where you're short yen, long treasuries. We saw the volatility in Treasury markets. You saw the weakening in treasuries, and you saw a rally in yen. So there's maybe some evidence that you had the unwind of the yen carry trade.

You also have risk parity funds that are going to be vol-driven. And you look at something like the VIX as well as the MOVE index. Both of those had spiked aggressively. And as VOL spikes, you have to de-risk and de-gross. So that just lends to more selling.

And then the third one we've heard a lot about is that basis trade, where people are going long or short, the cash market long or short, the treasuries against that and just playing that relationship. And, again, as that volatility starts to spike, the VAR managers get the tap on the shoulder and said, you got to rein it in a little bit.

And so those basis trade happens in massive leverage. And so you're going to get some de-risking on the back of that as well. So to us it was more a function of de-leveraging, de-grossing, in the markets that got reflected in the volatility in Treasury markets but something we'll be keeping an eye on going forward.

BRIAN HESS: So those are a lot of technical reasons why we may have seen a sell-off in bonds. How do you feel about the idea that the tariffs themselves actually create some bearish risk for the Treasury market?

So I look at the tariffs themselves as potentially being inflationary. And while normally you hear tariff announcements strengthening currencies, as the currency should offset the impact of the tariffs-- in this case, the dollar actually weakened, which enhances that import price inflationary risk. And we've already got a situation where inflation expectations are kind of unhinged. The latest UMich survey for medium-term inflation expectations has really lifted off.

So that creates some risk around second-round effects. If you get goods price inflation, could it spread through the rest of the economy? I think the other issue is that the tariffs do increase recession risk. I mean, we're not calling for a recession, but you have to admit that it's a bigger risk than it was two or three months ago. And we're already running a 7% deficit as a percent of GDP.

We know during recessions that tends to blow out. So if we add another 3% or 4% to the deficit based on stabilizers kicking in, now you're talking about a double-digit deficit. At the same time, we're kind of antagonizing a lot of people who fund that deficit, meaning foreign bond buyers.

So I do see how there's a fundamentally bearish story you can craft about these tariffs on the bond market. Do you think that's some of it as well, or do you think it's mostly just the technical deleveraging?

JACK JANASIEWICZ: Yea. I think there's also the concern that some foreigners are just saying, you know what-- if the US doesn't want to play nice with us anymore, we're not open for business anymore. I'll take my ball and go home, so to speak.

And so I think you've had some just people unwinding positions and saying, I'm just going to repatriate my money back home, period. And, yeah, there is a risk, what you just outlined on the fundamental side, that we have to rely on quite a bit of these foreign buyers to basically fund our deficit.

And we're keeping a watchful eye on the Treasury auctions. I think we had a three-year auction last week that didn't go so great. The next day, though, we followed up with a 10-year that actually was solid. So I think that's one of the things that we're going to be certainly paying attention to make sure that if there is some concerns with really the foreign investor sort of abandoning the US Treasury market in here, it'll show up in some of these auctions.

So that's one of the big tells that we're certainly paying more attention to than we have in the past. Exciting getting those tails and the coverage ratios printed off by the Treasury after the auctions. We're back to that again.

BRIAN HESS: Back to tracking that data.

JACK JANASIEWICZ: Yeah.

BRIAN HESS: And back in 2020, the last time we had talked about the basis trade unwind putting pressure on treasuries, the Fed was able to come in and really rescue the bond market. They printed an unbelievable amount of dollars and intervened to support yields. 

This time around, it's a little bit of a different situation because we have above-target inflation. And we're coming off that period in 2022 where the Fed's credibility came under pressure. So I think they're going to be a lot more cautious about supporting the bond market.

What is your thinking on how the Fed is probably perceiving the latest developments?

JACK JANASIEWICZ: Yeah, totally what you just outlined. 100% agree with. I think the July Fed meeting probably starts to come into play in terms of how we're thinking about things, because you probably get at least two inflation prints, if not three. You'd have to actually look at the release dates there.

But I think you'd get a better handle in terms of where inflation is going. I think the more recent prints we got between PPI and CPI-- you can basically extrapolate out and project out what PCE will look like. And PCE is the one the Fed cares about. You could have basically no increase on a month-on-month perspective from a core PCE release.

So, again, we are still seeing the potential for inflation coming down, but tariffs remain that wild card. And the Fed has actually said that. Powell had spoken on a Friday, where they did mention, like, listen-- we just don't going forward, and as a result we're probably going to sit on our hands and watch.

The hard part in here, though, is as they sit and watch, financial conditions implicitly are tightening. And that's going to be making that backdrop that much more tricky in here for them. So, yeah, wait and see. I think if anything we're basically looking at maybe that July meeting as the first time they move.

The other thing I would point to is also the Fed officials came out last week and were basically talking about the plumbing of the system. I think if we start to see the bond markets not functioning properly, you might see the Fed step in with some liquidity functions in here. But that's very different than stepping in because of concerns over the growth backdrop.

So just a slight difference there, but the Fed does stand ready to make sure that the bond market remains functioning.

BRIAN HESS: Yes. They might not cut rates aggressively.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: But they will provide the liquidity to at least stabilize volatility.

JACK JANASIEWICZ: Right.

BRIAN HESS: So this is another overhang, I guess, on risk assets, the fact that the Fed has to just stand off on the sideline for a little bit because, yeah, they might get some near-term inflation data that's more supportive. But the tariffs call into question how sustainable that will be and what will inflation look like three months from now. They just, I think, have a hard time being confident about that outlook.

JACK JANASIEWICZ: Yeah. And like you said, that just gives the Fed less confidence. I think you can extrapolate that less confidence to investors, to consumers, to CEOs.

BRIAN HESS: Yeah.

JACK JANASIEWICZ: It's a confidence story, and this is all making things much more challenging on that front.

BRIAN HESS: Now, we talked earlier about how the Treasury rates went higher in the midst of the volatility. But the dollar actually weakened, which is an unusual combination. And you mentioned the yen carry trade unwind where we had higher US rates and yet a stronger yen, which has not been the typical correlation. Usually, as US rates go up, the yen weakens. Dollar-yen rallies.

So I guess the conclusion a lot of people are coming to is that there's repatriation of capital out of the US back to home, to countries where it had originated. There's been a lot of money flowing into the US to buy tech stocks, to buy treasuries with their higher yields over the past few years.

And then the notion that was attached to these flows was US exceptionalism. That was the way it was typically described. So how much of a hit do you think the idea of US exceptionalism has taken from this tariff announcement?

JACK JANASIEWICZ: Yeah, and I think this is really the longer-term thing that you're thinking about in terms of themes. And from our perspective, US exceptionalism may be more dented than absolutely being completely reversed. Right? And think about a few things.

One, the US still has a strong military. So that, I think, gives a little bit of credibility to the dollar. But we also have one of the best functioning capital markets in the world. So that, I think, carries a little bit of weight as well. And we still have a pretty impressive tech sector with some of the things that are coming out of there in terms of developments and innovation.

So those three things alone, I think, still keep the US within play. But the other thing to think about too-- it's just the US consumer, right? And the US consumer is one of the global growth drivers. And if you take a step back, what are the two growth engines? It's always been the Chinese economy and the US consumer.

Yeah. Maybe we get a little bit of a shift as people maybe start to move a little closer to China in this whole thing. But I don't think you can abandon the US consumer here. It's just too big of a profit motivator for a lot of these foreign nationals. And I think that maybe keeps the US still in the game, so to speak, but, again, maybe less so than what we've seen over the last couple of years.

BRIAN HESS: So companies are going to find a way to work around these tariffs to access the US consumer.

JACK JANASIEWICZ: They always do.

BRIAN HESS: Just too big of a market, too big of an area for growth. And that will keep capital flowing into the US to some extent.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: All right. Well, let's wrap it up here for this month. Hopefully, markets will stay exciting. And maybe next time we can talk about some opportunities we're seeing out there, what looks attractive. But let's just let things play out a little more and see how these negotiations go. And we'll touch base in another month.

Thanks for the good conversation, and thanks to everyone for listening. We'll see you all next time.

JACK JANASIEWICZ: Yeah. Thanks, Brian. Take care.