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Good morning. Markets have mostly shrugged off Donald Trump’s threats of a 50 per cent tariff on Brazil. The country’s Ibovespa stock index was down only 0.5 per cent yesterday. The Brazilian real did take some heat, falling 2 per cent against the dollar after the US president’s announcement on Wednesday night, but it recovered throughout the day on Thursday. This makes sense: exports from the South American nation to the US are a modest percentage of Brazil’s GDP, and, as ever, who knows how serious Trump is. Email us: unhedged@ft.com.
Why isn’t there a Taco trade in copper?
The copper market does not appear to think Trump is going to chicken out on his 50 per cent tariffs on the red metal. The copper price rose 13 per cent when the levy was announced — reflecting, presumably, a rush to build US inventories ahead of the tariff’s implementation — and has stayed there. And that’s even after rising steadily for months:
The sharp move makes a striking contrast with equity and currency markets, which have been notably calm to threats against imports from Japan, Korea and Brazil.
What explains this? We see three explanations:
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Trump has stuck with his tariffs on steel and aluminium, which hit 50 per cent earlier this month. Industrial metals are especially important to the president, probably for symbolic and political reasons.
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The copper tariff seems relatively simple, and markets are more likely to price in things they think they understand. National tariffs cover a range of goods and will affect different companies differently. Exposures are complex and hard to calculate. The impact of the copper tariff is easier, in theory if not in practice: figure out how much copper is coming into the country (or company) and multiply by 1.5 to find the new price. The reality is that copper supply chains are quite complex, crossing back and forth across the US border, but reality is not always the main factor in markets.
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The copper tariffs make more sense than some others. There is a reasonably good national security case for the US having native copper supplies and smelting capacity, given copper’s importance in energy generation and Chinese dominance in smelting. And there are copper reserves in the US that higher prices might make more profitable to extract. That does not make the tariff economically efficient, but it is way less dumb than a tariff on, say, Brazilian coffee or Chinese toys.
The Unhedged view remains that Trump, when faced with real pressure from CEOs, markets, or voters, will give up his tariffs quite quickly. That said, however, the Taco trade is not monolithic.
Treasury issuance, the SLR and the Genius Act
The debt limit has been raised and Uncle Sam is free to refill his coffers. The Treasury has announced it aims to have $500bn in its general account by the end of July — implying about $125bn more debt issuance this month — and to bring the account to normal levels, probably $800bn or so, by September. How the US chooses to refill its coffers now, and later as it pays for Trump’s big budget, will matter for debt markets.
Treasury secretary Scott Bessent prefers Treasury bills and shorter-duration bonds. Asked if he would start issuing more long-term debt this year, he replied: “Why would we do that?” He is betting inflation and rates are headed down from here, or at least that we will get a more compliant chair of the Federal Reserve next year (the market is making the same bet).
Bessent may also be counting on new sources of demand for shorter-term US debt. The administration has lent support to the Genius and Stable acts, which provide a regulatory framework for stablecoins, and to last month’s proposed revisions to the supplementary leverage ratio (SLR), a bank capital requirement. Many observers expect these will increase demand for bills and, in the case of the SLR, shorter-term bonds.
Bessent may be disappointed on both fronts. Rates could remain high, obviously. The US economy is solid, and tariffs inflation may yet appear. The US’s fiscal trajectory was concerning before the budget passed, and now looks worse. If a “shadow” Fed chair is announced before Jerome Powell’s term ends next May, the bond market might revolt.
The stablecoin regulations require that issuers be fully reserved with short-term treasuries, reserves at the Fed, or bank deposits. Total stablecoin market capitalisation is now about $250bn; analysts’ guesses for the future size of the stablecoin market range as high as $2tn, and legitimacy from the new regulations is expected to deepen the market. That could boost Treasury purchases. But, as Brij Khurana at Wellington Fixed Income noted to us, where that new demand comes from matters for the market. If new stablecoin buyers are just taking money from their banks or money market funds, that is not net new demand for T-bills.
And SLR reform has not panned out exactly as many banks had hoped. Rather than exempting Treasuries from capital requirements outright, as the Fed did in temporarily in 2021, the central bank proposes lowering the overall capital ratio for systemically important banks from 5 per cent to 3 to 4.25 per cent, depending on the bank’s risk profile, and equalises the treatment of bank holding companies and their deposit-taking subsidiaries. That freed-up equity capital could enable Treasury purchases. But that will depend on the relative risk-weighted return on Treasuries. Ralph Axel and Mark Cubana at Bank of America argued that because reserves and Treasuries receive the same capital treatment under the SLR, the only reason to move to Treasuries is for the lift in yield, currently about 25 basis points for two-year Treasuries. The changes to the SLR will only support Treasury demand at the margins.
Favouring the short end of the curve can also have diminishing returns; markets can look through issuance slight of hand. And a short-term strategy can become dangerous when a sovereign has underlying fiscal challenges, as Robert Tipp at PGIM Fixed Income noted to us. “Think of the 1994 Mexican peso crisis, or Turkey, where on more than one occasion the rollover risk of short-term debt became the weak link in the system,” he said.
Thankfully, Tipp added, the US is nowhere near that point. While the new budget is big and US debts are growing, markets did not rebel when the budget was passed, and Treasury auctions remain healthy. And investors don’t love the alternative to Treasuries: long-dated sovereign bond yields have been rising across the developed world.
All policy choices are gambles. We hope Bessent is making a winning bet.
(Reiter)
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