The search for stability continues, despite rising stock markets

In a newsletter article in April this year, I discussed the increased uncertainty on global markets triggered by the aggressive trade policy of the United States and the resulting demand for value-preserving investment strategies, such as our value strategy in the equity sector.

At hindsight, we can see that the performance has confirmed this hypothesis: the “search for stability” that we described recently led to a stronger performance of these investment strategies, driven primarily by the depreciation of the US dollar and demand for equities of relatively secure companies. As a result, our fund, which invests according to this value strategy on a euro basis, achieved a return of almost 5% on top of the broad US equity market in the first three quarters.

Geo-economic situation remains tense

Today, we have to acknowledge that this uncertainty, shaped by US politics, has not been resolved in the third quarter. This is primarily due to the fact that the Trump administration is eroding confidence in the neutrality of political institutions through its interventions. After all, this neutrality is one of the cornerstones of the US economic system, on which foreign investors have counted for decades.

Following a weak labour market report, President Trump ordered the dismissal of Erika McEntarfer, head of the Bureau of Labour Statistics, which is responsible, among other things, for compiling inflation reports. In addition, the government increased pressure on Fed Governor Lisa Cook, who stands in the way of its ambition to cut interest rates further. One reason for this strategy is to artificially suppress interest costs, which have reached a new all-time high this year. On the one hand, this is meant to enable the government to take on new debt, which is needed due to tax cuts. On the other hand, the aim is to support domestic industry (“America First”) and the capital markets. The implementation of the “Big Beautiful Bill” could further exacerbate the situation and push interest costs as a percentage of GDP from the current estimated 3.8% (Q2 2025) to over 5% by the end of the decade.

However, this strategy of politically suppressing interest costs, combined with higher volumes of new borrowing, also led to the depreciation of the US dollar, as lower interest rates on US Treasury bonds do not adequately compensate investors for the higher financial risk they take on. This means that, assuming stable future performance of the US dollar, US Treasury bonds have now become cheaper for investors based in Europe, while the USA has lost purchasing power. So even for the United States, there is no such thing as a free lunch!

The relevance of the US dollar in the current geopolitical context

The stability of the US dollar and the attractiveness of US Treasury bonds to foreign investors are extremely critical issues for US financial policy. Thanks to stable economic growth, innovation and, above all, a high level of investor protection, the USA has attracted huge capital flows over decades, providing both the private sector (in the form of shares and bonds) and the government (in the form of Treasury bonds) with enormous financing capacities. This relationship between the exceptionally high demand for US Treasury bonds and the stability of the US dollar has been referred to, among other things, as “exorbitant privilege”, i.e. the privilege of being able to borrow excessively (abroad), as US Treasury bonds and, consequently, the US dollar, are in constant high demand as a safe haven.

This demand is so (exorbitantly) high that the United States, as the world’s largest debtor, has accumulated liabilities in the form of government securities amounting to approximately USD 60 trillion. After deducting US foreign assets, this results in a net asset position of USD -26 trillion, which corresponds to approximately 80% of US GDP. Consequently, it should be in the United States’ interest not to upset its creditors, as less demand for US Treasury bonds would cause their yields, and thus interest costs, to rise further. The Trump administration is trying to counteract this by putting pressure on the US Federal Reserve to further cut interest rates. However, this can only be partially successful, as only short-term interest rates are determined by the central bank, while longer-term interest rates are driven by growth and inflation expectations as well as market demand for government securities. In exceptional situations, such as the Covid crisis, the central bank can manipulate longer-term interest rates by purchasing bonds, but this crowds out other investors who would only be willing to invest in US debt securities at a lower price (or a cheaper US dollar) or a higher yield.

In addition, the US government is working to reduce its dependence on foreign capital by supporting the domestic industry (“America First”) and exports, thereby bringing money back into the country through trade surpluses. As we know, Donald Trump’s preferred tool for this is the use of trade tariffs. These are meant to strengthen the relative attractiveness of US goods on the international market and, in addition, to increase demand for them through the more favourable US dollar exchange rate. So far, the US economy has continued to grow strongly in the service and technology sectors, but gains in industrial production and exports have been largely absent, except for the new tariff revenues, despite an 11.5% depreciation of the US dollar index.

Investors seek (new) ‘safe havens’

As the macroeconomic environment has been changing at a historically rapid pace in the year to date, it is extremely challenging to make a reliable currency forecast for the US dollar. That being said, we can conclude that the US trade and financial policy is postulating a weaker currency. On the one hand, this is due to industrial policy in the form of tariffs and prioritisation of domestic production, which is driving inflation, and on the other hand, due to interest rate cuts and higher government debt (“Big Beautiful Bill”). The exorbitantly high demand for US Treasury bonds as the financial industry’s safe haven of choice, which still accounts for about 60% of global currency reserves, is counteracting this. As long as the US dollar does not lose this status, there is strong support that can offset bouts of historical depreciation such as those seen this year in the medium term.

In areas other than the currency markets, however, the search for safe havens for large capital flows has already left its mark. While gold and silver (both at all-time highs) normally absorb part of these capital flows, along with government bonds from other industrialised countries such as Germany and Japan, there is currently increasing demand for short-term corporate bonds, conservative (value) equity strategies, and Asia and emerging markets, which offer diversification effects for global portfolios thanks to their ability to generate growth increasingly isolated from the West. One reason for this is that fiscal discipline is declining not only in the USA, but also in European countries such as France, the UK, and Austria – and this despite falling productivity. Private companies cannot afford this and are therefore becoming relatively safer investments, both in the equity and bond segments.

 

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