The turmoil in financial markets triggered by Donald Trump’s sweeping tariffs has prompted comparisons with the mayhem unleashed by former UK prime minister Liz Truss’ disastrous mini-Budget nearly three years ago.
The US president’s “liberation day” launch of a global trade war and Truss’s unfunded tax cuts both spooked investors and threatened to unhinge the financial system.
Given the economic might of the US, Trump’s determination to reshape the global economic order looks certain to have a far more lasting impact on the financial system than Truss, who was ousted after only seven weeks.
Many on Wall Street had initially cheered Trump’s election victory in November as he committed to turbo charge growth by unwinding regulation, slashing bureaucracy and cutting taxes on his return to the White House.
Since then, though, the president has given financiers and regulators more cause for concern than for celebration.
Central to these fears is the worry that a protectionist US administration, that treats the key multilateral economic institutions, such as the IMF, World Bank and G20, with disdain, will fragment the global financial system.
“The current US administration’s tariffs are part of a broader programme of economic nationalism and using such tools to pursue geopolitical objectives,” says Lisa Quest, co-head of the government and public institutions practice for Europe at consultants Oliver Wyman.
A study published in January by Oliver Wyman and the World Economic Forum estimated fragmentation could lead to annual economic output losses of between $600bn to $5.7tn. At the top end, that would mean wiping out 5 per cent of global GDP — double the output losses caused by the 2020 coronavirus pandemic.
“It is not just the actual cost but it is the cost of uncertainty and the impact on trust,” says Quest. “Many of these markets operate on the basis of stability and trust and there will be an additional cost that comes from losing that trust.”
The recent sharp falls in US share prices, sell-off in Treasuries and a depreciating dollar suggest Trump’s volatile policymaking is eroding investors’ confidence and causing capital flight out of American assets.
Jamie Dimon, chief executive of the biggest US bank JPMorgan Chase, told the FT in a recent interview that he worried about a potential threat to his country’s traditional status as “a haven” because of its prosperity, rule of law and economic and military strength.
Trump has also been alarming boardrooms by targeting law firms that have represented his political opponents, launching wide-ranging investigations into diversity policies at companies and cutting off funding to leading universities such as Harvard.
“Clients are gripped by uncertainty and fear of reprisals,” says Anna Pinedo, a partner at US law firm Mayer Brown specialising in capital markets. “There is a hesitancy to make investment decisions. Boards and management teams are particularly fearful that they could be targeted because of decisions they make. It is a very difficult climate to operate in.”
The financial system has proved notably resilient in recent years, emerging largely unscathed from the sharp downturn caused by the Covid-19 lockdowns in 2020 and the energy crisis triggered two years later by Russia’s full-scale invasion of Ukraine.
While this resilience was partly thanks to vast amounts of government support in the form of loan guarantees, furlough schemes and subsidies, it also reflects how the banking system has been made stronger through reforms to raise capital and liquidity levels.
Yet there have been several incidents that regulators believe show the system remains vulnerable to shocks, including the crisis in the UK pension sector caused by Truss’s mini-budget in 2022 that led to a sharp sell-off in the country’s bond market.
In 2023, higher interest rates caused several mid-sized US banks to collapse, including Silicon Valley Bank, and Switzerland was forced to arrange a hasty state-backed rescue of Credit Suisse by its rival UBS.
A looming trade war threatens to add more strain on the financial system. “While banks remain well capitalised overall, and market movements have been orderly so far, they may be tested in the case of a full-blown risk-off episode,” Pierre-Olivier Gourinchas, the IMF’s chief economist, said in April as he announced a cut in its growth forecast for the world economy this year from 3.3 per cent to 2.8 per cent.
Higher government spending since the pandemic and subsequent energy crisis has sharply increased public debt levels, increasing the risk that investors will question countries’ debt sustainability and trigger a sudden surge in borrowing costs.
There are also fears about high debt levels in other areas of finance outside of the traditional banking sector that may make the system more vulnerable to shocks.
One example is increasingly popular “basis trade” by hedge funds to use large amounts of borrowed money to profit from small differences between the price of cash bonds and bond futures in the US Treasury market.
Rating agency S&P Global Ratings warned in April about the risks of the basis trade unravelling. “Given its obvious crucial importance for the global financial system, an adverse movement in the US Treasury market, for instance due to deleveraging by hedge funds, would reverberate,” S&P said in a report, adding it could drive up funding costs across the financial system.
Meanwhile, a trade war, along with military conflicts in Ukraine and the Middle East, have increased the threat of cyber attacks on the financial system. The Bank of England warned in April that “higher geopolitical tensions also create an environment of heightened risk of cyber attacks, which could coincide with, and amplify, other stresses”.
One of the biggest worries is that Trump could block the Federal Reserve from providing dollar liquidity to the rest of the world via the swap lines it maintains with various other central banks, which have acted as a key crisis-fighting tool in the past.
“There is no indication from the Fed that this might happen, but if central banks could not rely on these swap lines any more, that would be very serious,” says Andreas Dombret, a former executive director at Germany’s central bank.
Trump says he wants to reshape the global economic order more in the interests of the US. But observers warn this could backfire by upending a system that Washington has played a significant role in shaping as well as being one of its biggest beneficiaries.
The US has already signalled it may ditch the stricter capital rules for banks agreed by global regulators at the Basel Committee on Banking Supervision in response to the 2008 financial crisis.
Sir Paul Tucker, former deputy governor of the BoE, says the biggest beneficiary of the 2008 crisis was China and warns that Beijing would be set to gain an advantage again if financial regulation fragments.
“If Basel unravels, the set of banks that could come to dominate the world are the big Chinese ones — they have the giant state sitting behind them and so can compete with lower capital levels,” says Tucker. “It’s not good for Washington, or London, but it’s not bad for Beijing.”
