The truss moment comes to America: Markets react to US credibility crisis

Today we get the usual jobless claims, the flash S&P PMI, existing home sales, and the Kansas City Fed survey. There is also a 10-year TIPS auction.

The market may make hay out of straw with the jobless claims, which are creeping upward in both the weekly and continuing. Jobs are being lost in a lot of places, including small businesses dependent on imports and tourism, but immigration is way down so those jobs are available. The perennial question is whether Americans will take low-paying arduous jobs like lettuce picking, meat-packing and roofing.

The G7 finance ministers are still meeting in Canada and we are not getting any juicy press—except a completely confusing story about FX talks between the US and Japan. TreasSec Bessent met with FinMin Kato and agreed the current exchange rate does reflect fundamentals, as it should. Then the Treas Sept said exchange rates were not discussed but Kato said "We agreed that currency rates should be set by markets."

Reuters reports “The dollar briefly jumped to 144.40 yen after the U.S. statement, but the lack of confirmation from the Japanese side pushed back the greenback below 143.50 yen. Later on Wednesday, Japan's top currency diplomat, Atsushi Mimura, who also attended the bilateral meeting, clarified that Kato and Bessent neither discussed currency targets nor current rates. He said ‘Our understanding is that the U.S. side probably meant the agreed basic principles that currency rates should be set by markets and excessive volatility and disorderly movements are not desirable.’"

Oh, dear. Earlier reports had it that Trump wanted the yen at 100. Considering that all politicians lie, everyone here is lying. We do think the Mimura mention of “excessive volatility and disorderly movements” is the usual threat of intervention, however soft and distant.

The stock market didn’t like the 20-year Treasury auction outcome. Stocks fell. The bond market didn’t like the auction, either, and all the yields went up. The 10-year rose 11 points to a three month high of 4.597%. The dollar tracked the bond prices.

Reuters notes “The New York Fed's estimate of the 10-year term premium - the compensation investors demand for holding 10-year debt to maturity as opposed to just rolling over short-term securities - is close to its highest in more than a decade and almost twice its 20-year average.” Yikes!

As we wrote yesterday, the divergence of the dollar and the yield is rare. Then someone pointed out that we had the same thing in 2010 during the Grexit crisis—in the dollar/yen. This highlights that the yen is a safe-haven in its own right and perhaps not only to the  Japanese. There’s a lot to be said for stability.

One outcome: the probability of the Fed not cutting rates in July has risen to 71.2%. A month ago, two cuts were priced in.

Is this a “Truss moment”? The divergence of the dollar and the yield is getting attention everywhere. Krugman writes this could indeed be a Truss moment. Truss was the UK PM who cut taxes and raised the deficit to an extent that freaked out the bond market. The Gilt yield went to the moon and sterling plunged. Sound familiar? Truss got kicked out (lasting less time than the head of lettuce) but that’s not something the US can do.

Krugman writes “In a larger sense Britain’s crisis was driven by a loss of credibility.”

“These market moves in bonds and swaps show that the Trump administration is losing credibility, just as the Truss government did. Professional investors are ceasing to treat us as a serious country. “Instead, they’re starting to treat us like an emerging market, where budget deficits are a sign that things are spinning out of control. This irresponsible bill is already being seen as a signal to sell America, leading to higher interest rates, increasing odds of a recession, and a weaker dollar.

“And the example of Britain shows that things could spiral out of control faster than almost anyone imagines.” We wrote several weeks ago that the US might be becoming a third-world country in the eyes of investors. We were early. Now the evidence is mounting. We used to have a Minsky moment and a Lehman moment. The new moment is the Truss moment. 

Trump’s loss of credibility is shoved along by taking money from rich foreigners investing in his crypto, plus that airplane, which the US actually took possession of yesterday, and being rude to the PM of S. Africa on TV, obviously deliberate and an embarrassment to every citizen. Sending immigrants to Djibouti is a crime all on its own. Nixon was a saint compared to this guy. This is more than politics, it’s the news driving sentiment. Trump adores the limelight and can be expected to continue to drive away not only the tourists, but also the investors. Tigers and stripes.

Forecast

The top factor today remains the new US deficit, with the bill now going to the Senate. The CBO says the new deficit will be horrendous and even the non-liberal press says it’s cruel. There are cuts to Medicare, contrary to Trump’s promise. Bottom line, the mood is deeply negative.

But we usually expect a pushback after a big move in the bond and FX markets like yesterday’s. Traders do not like feeling fearful—it’s exhausting and can’t be sustained. Besides, the Friday before a 3-day holiday in the US is looming tomorrow, so squaring up can be expected to begin today. Position-squaring should not be confused with a shift in sentiment, although shocking news does lose its shine after a few days, especially when some other distractions come along. Trump is sure to deliver some before next Tuesday.

The only forecast that has a reasonable chance is that the yen will continue to get stronger. 

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