Weekly digest: as time goes by

Way back in 1988, I was living and working in New York. Little did I realise at the time that the seeds of today’s tariff wars were being sown at an auction of Hollywood memorabilia. One of the items for sale was a piano used in the classic film Casablanca. It was not the one ‘played’ by Dooley Wilson in Rick’s Bar, but one used in the flashbacks to scenes in Paris where the main characters, Rick and Ilsa, fall in love. Even so, it came with a hefty price tag of $154,000 (equivalent to $416,000 today). The winning bidder was a Japanese collector. The unlucky loser who was outbid was none other than Donald J Trump! According to legend, it is this episode that triggered his belief that foreign entities were taking advantage of the United States and today we are dealing with the consequences. I hope that he is not harbouring any other long-standing grudges that need to be settled. 

The last week has seen some calming down of the tariff situation following the de-escalation between the US and China. Perhaps that was because the President was on a whistlestop tour of the Middle East which involved announcing all sorts of investment deals, one of the biggest being the largest ever order for Boeing planes. This was announced by Qatar and amounts to $96bn. It makes for good headlines and provides more red meat for the MAGA crowd, but as with the British Airways deal announced the previous week, you still can’t persuade me that Qatar became suddenly enamoured of Boeing jets and placed the order to curry favour with the US. And it’s going to be years before they are all delivered (and even then, some of the order is only an option to buy). 

Meanwhile, the clock is ticking on the tariff pause which allows the US to ‘negotiate’ with trade partners. The main pause runs out on 8 July, with China’s extension running until 12 August. From a global perspective, what the US ends up agreeing with China and the European Union is going to be the most impactful. While all three parties are highly unlikely to end up cutting off trade entirely, it’s hard to see either China or Europe being quite as accommodating as the UK. There’s still the potential for lots of volatility over the next few weeks. 

In a bad Mood(y)

From a market perspective, equities have largely made the round trip back to where they were before ‘Liberation Day’ when the tariffs were originally announced. However, things are not as rosy in the bond market. The latest news is that the bond ratings agency Moody’s has downgraded the US by one notch from a pristine Aaa to Aa1. The fact that it’s 14 years since S&P Global made a similar cut makes you wonder why it has taken so long. There was nothing surprising in the reasoning, given projections of a relentless increase in the ratio of US government debt to its GDP and the rising level of the government’s interest payments as bond yields rise. Even so, US Treasuries took a bit of a hit, pushing yields (which move inversely to prices) up by a few more ticks.

This all comes at an interesting juncture as the Republicans attempt to pass their budget reconciliation package through Congress. For all the talk of DOGE cost cutting, reducing the deficit and getting bond yields to start with a “3” (at the time of writing 10-year Treasuries were yielding 4.55%), it looks suspiciously like classic ‘pork barrel’ politics aimed at shoring up votes in the mid-term elections next year. Over the next ten years, the proposed package offers almost $5 trillion in tax cuts. This includes extending $2.2 trillion worth from the Tax Cuts and Jobs Act in 2017 that are otherwise due to expire. Without this extension, there would be a severe tightening of fiscal conditions. 

Talk about the ‘never never’. One of the ways of getting that Act through the House in 2017 would have been to promise that the cuts were temporary. The old joke is that there is nothing so permanent as a temporary tax – that now seems to apply to tax cuts too! These cuts are offset by around $2tn of tax increases, but there is an element of smoke and mirrors here too.  A cap of $30,000 is being proposed on the amount of state and local taxes (SALT) that can be offset against income for federal tax purposes. However, the supposed savings of $915bn are relative to what would happen if the existing cap of $10,000 expired leaving no upper limit, as it is scheduled to at the end of this year. The $677bn savings on spending related to tackling climate change are worrisome for other reasons.

The point to make here is that, for all the talk of being less profligate, the current US administration seems to have little appetite to consolidate. This is once again raising questions about whether the US is set to face its own “Truss Moment”, which has become market shorthand for a sharp sell-off in bonds and the local currency as investors lose faith in the country to honour its liabilities (at least in real, inflation-adjusted terms). Such talk can sound alarmist, especially given the dollar’s position as the main global reserve currency and the incredible depth and liquidity of the US Treasury market, but we have learned to have to think the unthinkable in recent years. 

In reality, the fact that US Treasuries are the bedrock upon which the whole global financial system is built means that there is a huge incentive to avoid any disruptive market failure at all costs, even if that means intervention by the Federal Reserve. However, in the longer term, the most expedient solution for the US, barring some sort of unexpected productivity-led growth miracle, is to inflate its way out of the debt. This could be done by allowing nominal GDP (not adjusted for inflation, which is the standard way GDP figures are reported) to grow by more than the level of interest rates, much as it did following the Second World War. I continue to believe that this is one of the risks that investors in gold (which can act as a hedge against inflation) have detected. 

The UK is caught up in this too. In the aftermath Since the Truss Budget in 2022 in 2022, the UK has had to pay more for its debt relative to other countries than it did previously. During the early summer of 2022, the 10-year gilt yield was around 0.8 percentage points (ppt) higher than that offered by German bunds. Today, the spread is more than 2 ppt. Even though France continues to suffer its own political travails, its 10-year debt yields 1.4ppt less than ours versus 0.2ppt in mid-2022. At the same time, the UK was paying around 1ppt less than the US on 10-year paper. Today it is paying 0.15ppt more. 

Once the market’s trust is lost, it's very difficult to rebuild it. That’s one reason why Rachel Reeves, the Chancellor of the Exchequer, is having to be conservative with her plans and keeps referring to her fiscal rules. Although some of the UK economic data has been a bit better than expected recently, there is little evidence that this is helping the country’s finances. There is a risk that the build-up to the next Autumn Statement could feature more threats of tax increases.

It’s still the same old story… 

The version of As Time Goes By used in Casablanca does not include the main introductory verse of the original song (and neither do many other versions if a brief Spotify search is anything to go by - although Tony Bennett did give it the full treatment). However, should you not be familiar with the lyrics, written in 1931 by Herman Hupfeld, they do seem to apply remarkably well to life today, nearly a century later. 

“This day and age we're living in
Gives cause for apprehension
With speed and new invention
And things like fourth dimension
With Mr. Einstein's theory.”

And so, with a Bank Holiday coming up, we should take Mr Hupfeld’s advice that follows:

“So we must get down to earth at times
Relax relieve the tension”

As for investing in Hollywood memorabilia, Trump missed out on some decent gains because that piano was last recorded as being sold for $602,000 in 2012. Even so, he should have gone for the most expensive lot on the night, a pair of Dorothy’s ruby slippers from The Wizard of Oz. These turned out to be a snip at $165,000 when they were sold again last year for $28 million! 

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