Newsletter commentary May 2025

Trump Sparks Tariff Tensions, but Market Focus Unexpectedly Shifts to Debt Sustainability Issues

In early May, China’s reciprocal tariff measures yielded tangible results. Confronted with domestic political and economic pressures, the Trump administration subsequently softened its tariff stance, triggering a significant market rebound. Yet, as the dust settled, market attention gradually shifted toward more fundamental concerns—specifically, the long-term sustainability of U.S. debt. While tariff-related uncertainties persist, other nations have also begun refining their negotiation strategies to adapt to the evolving trade landscape.

Investors are beginning to question some long-standing investment paradigms. The traditional definition of safe-haven assets is being shaken, and signs of capital outflow from the United States are emerging. We are beginning to see intermittent occurrences of a rare “triple whammy”—simultaneous declines in U.S. stocks, bonds, and the dollar. A previously unseen shift is starting to take root in global capital flows.

Beyond well-known alternatives such as gold and cryptocurrencies, and beyond Japanese and European assets which investors are starting to consider, we believe renminbi (RMB)-denominated assets could become one of the main beneficiaries. This is due to China’s large economic scale, robust economic vitality, reasonable asset valuations, and the continued improvement in capital market’s breadth and depth.

Since the tariff issue emerged in April and later subsided, many stock markets have returned to their April levels. However, U.S. Treasury yields have continued to rise significantly, and the U.S. dollar index has dropped sharply. Japan’s long-term bond market is also experiencing a lack of buyers. This situation is starting to resemble the UK under Liz Truss, when concerns over debt sustainability led to a crisis in both gilts and the pound. Now, similar doubts are arising over the sustainability of U.S. debt.

For the past few decades, the careers of financial professionals have largely unfolded under the backdrop of a steady decline in U.S. Treasury yields—from nearly 20% all the way down to zero. Much of our understanding has been imprinted by that era. From Greenspan’s “conundrum” of low interest rates, to the widespread acceptance of the “new normal” of low growth, low inflation, and low interest rates, financial thinking evolved accordingly. This new normal was not just accepted—it was leveraged. For example, Janet Yellen once argued that the metric for debt sustainability should not be the debt level itself, but rather the sustainability of interest payments. People came to comfortably accept the benefits of low rates, with Japan serving as a leading case study.

After the pandemic, inflation was initially seen as transitory. The policy framework was even adjusted to emphasize average inflation targeting. These were all manifestations of a deep consensus—both in academic and practical circles—that low rates were here to stay. When something lasts long enough, we inevitably find ways to rationalize it, until it is eventually disproven.

People forgot that debt carries a burden. Policymakers who do not intend to manage for the long term naturally prefer to mask problems by issuing more debt. They justify this by claiming that debt-fueled growth will eventually improve the debt-to-GDP ratio. That’s how we ended up with Trump’s pandemic-era stimulus, Biden’s even larger fiscal spending, and Trump’s promised return with another round of ambitious deficit-expanding plans. Similarly, Abe’s relentless push to stoke inflation in Japan followed the same logic.

Now inflation has arrived. The financial allocations and behaviors shaped by decades of low inflation and low interest rates are now facing unprecedented challenges. It’s like a housing market that rose for 20 years suddenly turning downward—the impact is immense. But the financial market is even larger and more complex than real estate.

Over recent years, some insurance companies have faced a shortfall in domestic asset yields, prompting them to channel capital into U.S. equities and Treasuries. During periods of U.S. dollar strength, this often entailed unhedged currency exposure or a significant shift toward long-duration assets. Now, many of these strategies are showing signs of reversal, and insurance companies are just the tip of the iceberg.

The strong U.S. dollar itself is under question. Is a strong dollar really in U.S.’s best interest? Even if it is, is it still feasible to maintain one? These are no longer rhetorical questions. With nearly ＄40 trillion in U.S. debt, stubborn inflation, and a Trump administration showing no intent to rein in deficits, debt sustainability has become a visible and pressing issue. For institutions heavily exposed to U.S. risks, diversification may start to become a reflex rather than a considered strategy.

Looking back, there are almost no examples of a “beautiful” deleveraging. China’s economic trajectory—adding leverage while simultaneously building out new industries—is already considered an admirable exception. In contrast, many other countries used leverage merely to fund consumption. Short-term debt problems are often deferred by further debt expansion, only to become medium-term issues. Today, we are witnessing many countries arrive at the tail end of their long-term debt cycles. In the past, the absence of inflation and ultra-low interest rates masked the true cost of debt. But now that inflation is here—and likely to persist—painful deleveraging appears increasingly inevitable. We should prepare for outcomes such as defaults, runaway inflation, sharp declines in social welfare, wealth redistribution, and domestic conflicts being offloaded onto the global stage—all of which are no longer far-fetched.

Even now, at the end of the long-term debt cycle, some governments are being forced to add more leverage. Take NATO’s push to raise defense spending to 5% of GDP. For Germany, whose federal budget is around €500 billion, this would mean nearly €200 billion in defense outlays—up from just tens of billions today. This entire gap would need to be funded by new debt.

Much of what we once took for granted in a low-interest-rate world now appears to have been a temporary illusion. Japan’s 400% debt-to-GDP ratio didn’t trigger a crisis, but that was a special case underpinned by Japan’s high domestic savings. The U.S. has used the dollar’s hegemonic status to run persistent fiscal deficits and trade imbalances. The strategy may have a ticking clock. 

The belief that China’s high savings could only be absorbed via the U.S. trade deficit is another myth. These savings can just as well flow into equity investments in Belt and Road countries. Currency internationalization doesn’t necessarily require a trade deficit to export liquidity—Japan has already “rebuilt half of Japan” overseas through outbound investment.

While the world is increasingly worried about inflation and its damages, the negative narratives around China’s low inflation over the past few years may ease—or even reverse. Currency, at its core, must fulfill several functions: medium of exchange, store of value, and unit of account. The renminbi can already buy nearly everything one needs for daily life—and often at the best value globally. Once, we used Big Mac purchasing power parity to measure this; now we have electric vehicles from BYD and many other real-world products showcasing China’s pricing edge. Post India–Pakistan tensions, even self-defense tools with great cost-performance are being added to the RMB ecosystem. Taken together, renminbi-denominated assets have the potential to become the new undervalued corner of the global financial system.

Of course, there are many tools policymakers can deploy to soften the contradictions. These include making debt purchases by financial institutions tax-exempt, using stablecoins to boost demand for Treasuries, imposing tariffs, levying capital gains and remittance taxes, engaging in yield curve control or other distortions, reversing central bank QT back to QE, or directly supporting the Treasury—even more aggressive tactics that verge on outright expropriation. But what makes this time different is that investors are starting to doubt the sustainability of these strategies—and are beginning to act on that doubt by reallocating to alternative assets.

Many of the unconventional measures adopted by the Trump administration have revealed a thought-provoking reality: the traditional "hegemon" is facing growing challenges in resource coordination and strategic sustainability. By nature, capital is profit-driven and inclined to seek diversified options. Some market participants are now exploring more balanced cooperation frameworks, rather than relying solely on the traditional hegemon. Meanwhile, the uncertainty surrounding the hegemon's future policies remains significant.

The narrative logic of "American exceptionalism" is undergoing a new process of deconstruction. Historically, the U.S. has long wielded strong unilateral influence in international affairs through its systemic advantages, often constructing rules without bearing commensurate costs. However, the "boomerang effect" of policies has become remarkably pronounced today: many U.S. measures, while imposing pressures on targeted entities, often inflict comparable or even more substantial repercussion on themselves. The limits of its power are becoming increasingly evident. Wall Street analysts have even coined the term "TACO" (Taking A Cut Ourselves) to characterize this emerging trend of self-inflicted costs.

The reversal of a decades-long investment narrative means that global financial capital allocations—once considered optimal—are now being modified. We may be fortunate to have lived through one of the greatest economic miracles in human history, and perhaps we are now standing on the threshold of another chapter: a great migration in global capital allocation.