Trump’s reciprocal tariffs: Our fixed income experts react

Ariel Bezalel & Harry Richards – Investment Managers, Fixed Income

The new trade policy measures announced by the Trump Administration and the market reaction to that look quite concerning to us. A complete picture on how different countries will retaliate has not emerged yet. Retaliation could be merely symbolic, in an attempt to seal a deal or it could be aggressive. We already see different approaches emerging. China, a significant US trading partner, has hit back with a hefty 34% import duty on US goods. At this stage uncertainty remains extremely high.

One possible consequence from this could be a “closure” of the US goods market to foreign countries. While this might generate some shortages in the US, it could also mean the rest of the world could face excess supply. Longer term this is likely to encourage manufacturers of all sorts to build plants in the US. There’s already some talk of China and the EU adopting a pro-growth fiscal policy, which could help offset some of the negative growth impact coming from tariffs.

Risk markets and credit more specifically still look rich in this environment notwithstanding major movements seen in the last few days. In fact, we have been highlighting the overvaluation in risk assets for some time. We could see very different scenarios according to how negotiations evolve in the coming weeks. A large flow of trade deals could lead to meaningful risk rallies and a pullback in rates. If tariffs were however to stay for a more prolonged period there could be more disruption as risk markets are nowhere near pricing the full economic consequences, especially if EU countries were to retaliate hard and go after US services. Some of the movements across equity, FX and commodity markets by themselves look quite large and could have some spillover effects too. Trump has been speaking about the unfairness of trade towards the US for many decades and in this term, as opposed to Trump 1.0, is surrounded by a team that agrees with him. Therefore, he's unlikely to capitulate anytime soon despite these large market moves.

At this stage, being long treasuries via the short to medium part of the curve in the US feels more comfortable than the long end as the selloff in the US Dollar was becoming somewhat disorderly which could ignite inflationary fears down the line if the trend continued. Gilts valuations are outright cheap across the curve.

Hilary Blandy, Investment Manager, Fixed Income

Markets are reeling from the worst-case scenario on tariffs and the realisation that “Liberation Day” has not liberated global economies from very elevated levels of policy uncertainty. How US consumers react and whether Trump’s approval ratings can survive as US growth shrinks and inflation soars is another question, although the US Administration could yet change tack from here. The generic risk off move in equities has been mirrored in credit markets. Spreads are wider across the board with high beta and tariff impacted names have been the most affected. US high yield has been more impacted than European names. Market volatility tends to create spread dispersion, generating opportunities for active credit selectors to outperform. Our team is focussed on using a bottom-up approach to identify potential investment opportunities that now look attractive in this somewhat wider spread environment.

In this environment, we believe, high quality duration will help mitigate the spread widening seen on the high yield segment. Industrial sectors are most directly vulnerable to tariffs. High yield bonds sold by domestically focussed European issuers may experience headwinds if consumer sentiment weakens. However, our credit research process involves detailed stress testing of the capital structures and have room to survive a weaker growth environment.

Luca Evangelisti, Investment Manager and Head of Credit Research; Paridhi Garg, Investment Analyst, Fixed Income

The tariffs announcement has had a significant impact on banks equity valuation but so far to a much lesser extent on banks’ credit valuation. AT1 valuations across currencies have had a much milder negative reaction vs. bank equities. While insurance bonds and in particular RT1s have widened too, they are still well inside the wides of 2024. The move wider in spreads has been exacerbated also by the rally in government bonds which have partially compensated the price impact on AT1 and RT1.

Fundamentally, banks are not at the centre of the tariff-induced weakness. The impact on banks can be of second or third order as banks lend to companies that can be exposed to a certain extent to the introduction of tariffs in different sectors of the economy. While US banks are the most at risk in our view given the increased recession risk, in Europe we believe German banks are potentially most exposed given their exposure to companies active in automobile, chemical and technology sectors. However, the large fiscal package introduced by the German government should balance the economic shock. We expect a smaller impact on UK banks and also on Peripheral banks. The main risk in Europe remains the second or third order effect of potential increase in government spending given the reduced fiscal headroom in certain EU countries (such as France) with potential consequences on government bond spreads to which banks have exposure to.

We do not expect this dynamic to impact credit valuation in the short term. Furthermore, the capital position is very strong across European banks and is expected to shield well any potential deterioration in asset quality from current levels.