Tim Graf: This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Markets. I'm your host Tim Graff, head of Macro Strategy for Europe. Each week we talk about the latest insights from our award-winning research as well as the current thinking from our strategists, traders, business leaders, clients and other experts from financial markets. If you listen to us and like what you're hearing, please subscribe. Leave us a good review, get in touch. It all helps us to improve what we offer. With that, here's what's on our minds this week.

Over the last month, the total returns on US stocks are flat. The total returns on US Treasuries, also flat. The dollar, it’s net weaker by about 4 percent, but most of that happened in the first half of April. For the last three weeks, the dollar index is also flat. Which is remarkable, considering market measures of volatility and our own gauges of asset and currency market turbulence went absolutely haywire during the month of April.

But we now seem to be entering a lull, where nobody quite knows how to remodel the global economy, thanks to still tremendous uncertainty around US trade policy, yet where we have also emerged from a massive volatility event, with most portfolios only having a few bumps and bruises, rather than broken bones or head wounds.

As you'll hear in a moment, though, it's all very tiring. And my guest this week, Lee Ferridge, who runs the Macro Strategy Team in the Americas, he and I talk about how to approach the next few months. This period when clarity on US economic and trade policy will still be in short supply, but where position risks are also much more scaled back versus the beginning of Q2.

With a combined age between us that runs in the triple digits, the fatigue while we wait it out is evident. Hello. Hello.

Lee Ferridge: Hello mate, how are you?

Tim Graf: I've been very tired.

Lee Ferridge: I feel the same. I think it's these markets and everything else, it's a lot to digest.

Tim Graf: It's just, it's very, very tiring. And then I've got travel next week, so it's just so…

Lee Ferridge: No, I'm just glad I’m not the only one. I haven't got all that other stuff going on, but, but just this market is just, it's hard to put a finger on it.

Tim Graf: It is just exhausting to not really know what to think.

Lee Ferridge: That's exactly it. I find it really frustrating that I don't have a strong view because I just, I don't know what to think here.

Tim Graf: Well, this is going to be a good podcast.

Lee Ferridge: Yeah, exactly. “Ooh, I don't know.”

Tim Graf: Have you done a lot of client meetings lately?

Lee Ferridge: Yeah, I've done a lot this year, yeah. I mean, not, not probably over the last couple of weeks so much, but yeah, they're the same. They don't know what to do. So even if you know what the tariffs are, I'm not sure anyone really knows what the economic impact's going to be. Yeah, we know the direction, we don't know the degree. Actually, I thought it would be interesting to ask you what clients are asking you the most about and to get a sense of what your answer to that might be.

So is there what question is the most top of mind with all of this uncertainty around?

Lee Ferridge: The one they're asking me about specifically is dollar positioning. I think that's the one. People realize that in terms of a macro outlook or a firm macro view right now, no one knows. And if people think they have a strong macro view right now, then they probably don't understand the question. Clients asking me aren't really asking what do you think of growth this year? Or what do you think of the Fed this year? It's more about, look, no one knows. It's more about what we can provide in terms of positioning, where are the extremes? What are the moves? Who's doing what in terms of our flows, that's the most valuable thing we can bring right now.

Tim Graf: So for context, the positioning metrics we have for the dollar overall had been overweight for three years, I think there abouts. The unwind has taken place throughout first quarter into the start of the second quarter, and I think it was last week. Officially we have a dollar underweight now for the first time in that three, three-and-a-half year period. And so I guess the natural extension of that question is what do you see needing to happen for that underweight to extend and become perhaps as big. An extreme as the overweight in the dollar that we were seeing prior to this year.

Lee Ferridge: I think things have to get a lot worse for that to happen. The thing is, the dollar still has going for it is carry to sit underweight. So the last three years you rightly say real money had been sitting overweight. The dollar, you know, it's worked most of the time, but they've always had positive carry in that environment. Now if you're going to sit meaningfully underweight the dollar, you are paying away negative carry. That's not a comfortable position for people to be in in order to see, I think real money investors really go meaningfully underweight underweight the dollar, the outlook for the US has to get a lot worse, I think. And we look, we've seen growth expectations come down. We were sort of 2 percent for this year. We're now 1.4. There's lots of recession talk, but the hard data thus far has held up. Expectations have come down, you know, reflecting in that, that lower growth projection. But the numbers as they've come out have actually been okay.

We need more bad news from the US I think to see real money investors really push against the dollar and really be comfortable sitting with a dollar underway and paying away carry.

Tim Graf: Do you see the potential for any good news though, coming down the pike?

Lee Ferridge: We have these various trade deals ongoing, so there's potential there for some trade deals to be struck. Look, I think we're still going to end up with significant tariffs. I think most countries will end up at 10 percent but there will be certain ones that are at higher levels. I think China will obviously be not 145, but it could be 50 or 60 percent. Although worth remembering, I think the net tariff on China was around 40 percent anyway, but it'll be higher than that. I think Mexico and Brazil will. Mexico and Canada, sorry, will end up with where we are now, the 25 percent. But with the USMCA carve out, which brings their effective rate to 12 and a half to 15 percent. I also think the Eurozone isn't going to get a deal. I think the Eurozone will end up at 20 percent.

The reason why, look, you end up with China, Eurozone, Canada, Mexico, they're the four biggest importers to the US and I do believe there is a revenue element to this tariff policy. If you're going to make any meaningful revenue from it, those four have to pay a higher rate. You can have 10 percent for the rest of the world as long as those four are higher. And then you have your steel tariffs and your autos, et cetera. You do end up with around US$500 billion a year in revenue. Those are the sort of numbers I think the Trump administration wants. So this is where I think we will end up. But you will see that 10 percent elsewhere. I still think the consumer's going to hold up. You know, the US consumer continues and has for the last couple of years has outperformed what people expect.

You remember a year or so ago, 18 months ago, we heard about how the excess savings from the pandemic were all used up and that was going to cause the consumer to retrench and the economy to slow. Didn't happen. Now we're hearing the tariffs and higher prices are going to cause the consumer to retrench and slow. They will to an extent. You can't buy the same amount when the prices are higher. I still think with the unemployment rate relatively low, with the labor market in a balance, we saw the latest payrolls number. 177 is a good number. That's pretty much solid where we were growth. That being the case, I don't see a big collapse in consumption. And we know the US is a consumption driven economy. I don't buy into the recession talk.

If we end up with a level of tariffs I'm pencilling in, I don't think we end up with recession. I actually think we could beat that. 1.4 percent is now the consensus. Don't forget as well, there's a sequencing issue with Trump policies. If you think about there are six main economic policies for this year and for the next couple of years. Really Tariffs is one, Doge was another one. And immigration. Those are three of them. They're all growth negative. They're the ones we have now. The positive ones for growth are fiscal stimulus, which is making its way through Congress, deregulation, which we haven't seen a lot of yet, but we're expecting that to accelerate. And energy policy. Don't need the energy policy right now because oil prices come down so far anyway. Those ones are sort of in the pipeline. They're coming and they're growth positive. So I think the first half of this year or so far in the administration it's been about the growth negative policies. But what's coming over the coming months and quarters is going to be the more growth positive. So this is where I think that the economy can probably hold up better than most people think.

Tim Graf: So I find it ironic that a tariff regime that I'm just doing the back of the envelope math in my head, but based on what you've said, everybody's going to pay 10 percent or be charged 10 percent. And then you have the various scenarios for Europe and China and Mexico and Canada that you laid out. That's still a huge increase in the effective tariff rate on imports to the US economy. And admittedly the US economy is more closed than others, but that's still a large hit or lowering of real income. What keeps the consumer buoyant in that case? Whereas you say they've used up household savings, which is true, but labor income, as you've also alluded to, has remained growth has remained relatively robust there.

What further impetus does the consumer get to exceed those lowered growth expectations?

Lee Ferridge: Now I think wages will hold up better than people expect. I think, you know, don't forget I mentioned the immigration policy. We're going to see a big slowdown in supply of labor. We're already seeing it. The participation rate, if you look at 25-to-54-year-olds, is basically within striking distance of the highest it's ever been. The levels we saw back in 2000, you're not going to get participation above where we are now in terms of labor supply. That's going to be very limited going forward given the immigration policy we had. Now, immigration policy, that means that is a growth negative over the medium-to-long term, lower labor force growth. But for this year, what it could mean is higher real incomes for incumbent workers. And I think that helps to support the consumer. So you're going to see higher real income growth. You rightly say you're going to have these tariffs, but there are going to be tax cuts to offset that. No tax on tips, maybe no tax on overtime. Other fiscal stimulus, the package is about five-and-a-half trillion now, four trillion dollars of that is extending the 2017, but there's still a net one-and-a-half trillion. And I'm not talking about the consumer growing or spending at the same pace as we've seen previously growth in the last couple of years. The whole US exceptionalism period, we were 2.9 in 23, we were 2.8 in 24. That's significantly above trend growth. Trend growth in the US is around 1- 1.4. So the expectation now for this year, as I said, is 1.4, 1.5 for next year. Could we grow closer to trend? So 1 percent below what we were, but actually around trend, even with the tariffs? I think it's possible.

Tim Graf: So this is more a case of avoiding recession as opposed to as buoyant and exceptional a story as we've been used to the previous couple of years. Is that right?

Lee Ferridge: It is. But the other side of the exception story obviously is, is the rest of the world and the US tariffs are going to hurt growth in the rest of the world. The US is a huge consumer of what things that other people make. So there has to be a hit to growth in the rest of the world. So the relative growth could still actually be okay. So US comes down by 1 percent, others come down by 1 percent. But that relative US exceptionalism could actually persist for now.

Tim Graf: Thinking about expectations, I don't know anyone at this point who is aggressively bullish on risky assets. We've seen, of course, the correction in response to the tariffs in early April, fully reversed within a month. Amazingly, we finished April basically flat on equities, which I don't know if anybody would have expected that if they had perfect foresight, what the tariff regime was going to look like. And so I'm just wondering from here, and especially if you can tie in some of what institutional investors are saying, again, given expectations now have been revised significantly lower for earnings and for where the ultimately where the indices are going to be heading by the end of this year.

Do you have a strong view that risky assets now represent a buying opportunity again after this lowering of expectations?

Lee Ferridge: Not a strong view. They're a buying opportunity, no. Do I think the S and P will end the year above where it is now? Yeah, I do. Do I think it will be positive for the year overall? Yep, I do. We're only down 4.4 percent since the start of the year, which given everything is quite remarkable actually. And a key element here, don't forget there's still a lot of liquidity in the system. You know, excess reserves of the Fed are still, you know, north of US$2.5 trillion, we see US$7 trillion in money market accounts. You know, in our asset class weights, real money are still overweight cash compared with their long term average. Not a massive amount, but they're still overweight cash. They're overweight equities as well compared with the long run average, but they're overweight cash. The sort of conundrum on this, I guess is nobody wants to touch duration again. We see that in our indicators. We see consistent selling of 10 years and above in Treasuries, which means unless you're going to sort of sit in cash, where do you go? And people don't sit in cash for that long. They tend to go back into equities. The conundrum is at what point do yields become attractive? So I think what we're going to have is this backdrop of equities holding in, drifting higher. I think we've reached peak pessimism in terms of level of tariffs that came on April 2nd. They're not going to be as high as those announced that day. We know that, I think so I think you will see this drift back into equities out of cash, but then yields continue to drift higher as well. And at what point do we see yields are actually a viable or duration as a viable alternative to equities? We're not there yet.

Maybe north of 4.75 on the 10 year, towards 5 percent maybe then it becomes a viable alternative but there's no indication from our data that we're anywhere near that point yet.

Tim Graf: This brings up an interesting question and one that I talked about with Mark Rosenberg from Geoquant about last week, which was this decoupling of US rates and the dollar. I presume in your view that means the dollar drifting higher as well or at least fighting some footing.

Lee Ferridge: Is that right from here the dollar reflects the lower expectations for the US economy. It reflects the higher uncertainty surrounding it. But we're down 10 percent from the highs that we saw in January. But the DXY has basically been between 99 and 100 for the last month. I think it's forming a base. Do I believe that we're going back to the highs where we were? No, I don't, I don't. I think the €105, those sort of levels that's gone. Could we get back towards 110 on euro? I think that is feasible.

Tim Graf: What then would you ascribe that blip to? If it is a blip indeed. That decoupling that I talked about last week that made people sit up and take notice, I think probably made the administration sit up and take notice as well. This notion you had sharp dollar weakness in an environment of not just high volatility and equity markets drawing down but higher US rates as well. That kind of doom loop EM-like behavior you saw.

What would you ascribe that to?

Lee Ferridge: I have my suspicion. I think there were certain actors or central banks that were selling Treasuries and selling the dollar in order to pressure the administration. Whether I would, there would never be any way of proving that.
But I, you know the price action over those particular few days was remarkable. The relative 10-year spread in euro dollar is one of the strongest relationships you get in FX and they just went in totally opposite directions which you know to me was, was a sign that there was something unusual going on there in terms of the participants in the market and I probably can't say any more happened.

That's the way I sort of, I looked at that. Do I think that relationship will reassert itself? I do. I don't think that the dollar has suddenly become an EM currency that you know, higher rates lead to weakness. That doesn't really happen in the DM world. We had the, in the UK there was the Liz Truss period where high gilt yields and lower sterling happened. But it was very short lived. That sort of dollar move was, was largely short lived as well. It's not that the dollar is strengthened on the back of the high relative rate spread, but it stopped falling.

Tim Graf: Do you have any thoughts about the dollar's appeal over the long term?

The questions of dollar dominance that we've talked about in this podcast that is, you know, it's a common theme running through, related to this discussion, but I think also ancillary to it as well, you can have diminished dollar standing without this doom loop, I think, and I'm just curious where you stand on this. Not just for the next month or three months even, but where the dollar sits in investor portfolios over the next five years, 10 years.

Lee Ferridge: I think it's still the major component. I think the US economy is still extremely dynamic. The most dynamic companies in the world are in the US and the more the focus comes on technology, the US has an inherent advantage there, be that, you know, structure of funding for startups, be it the regulatory environment, whatever the explanation is. But the US has this inherent advantage when it comes to technology and technology companies. And I think that portfolios will continue to favor those types of companies and that will continue to favor the US so I think the US continues to play a huge role in portfolios. If we're thinking about reserves, it's still going to be the reserve currency. Its share of reserves have been going down for decades. There are clearly political challenges right now to the US standing in the world. Do I think that will duly undermine the dollar's reserve status? I don't see it. And one of the major reasons is what's the alternative? There just isn't an obvious alternative to the dollar as the world's reserve currency or the world's medium of exchange. All the issues over euro, you don't have common euro debt, the decision making process, et cetera, renminbi, not fully convertible, not a current account deficit. All of those arguments that have been trotted out over and over again, they're still valid now. Does this mean the dollar can never depreciate? No, absolutely not. I mean reserve currency status and the actual dollar direction of travel for the value of the dollar are two different things. The dollar, we've seen it, we saw it in the ’80s, we've seen it in the past. The dollar can go up, the dollar can go down, but it's still the reserve currency. It's still the main medium of exchange in the world.

Tim Graf: Play devil's advocate to yourself.

If you had to allocate reserves and in just a small portion as a diversification vehicle, which currency would you choose for this five, 10-year view to put a little bit more into maybe at the expense of the dollar?

Lee Ferridge: Probably the yen will be my currency of choice. I think we know the valuation and it's been a value trap for a long time. The undervaluation of the yen, but the inflationary, the wage inflation pressure that's starting to come through and has been coming through in Japan is real. I don't think it's another false dawn. I think this is to do with demographics. I think it is to do with the fact that the manufacturing jobs that when the demographic problems hit in Japan, jobs were manufacturing jobs moved overseas. Well, now the demand is more for services and services employees. You can't largely particularly healthcare, you can't export those jobs against declining population. Demand for labor will hold up. That's going to lead to higher structural wage growth which in turn will lead to higher inflation. So you know, the idea that, you know, Japanese rates will remain lower than the rest of the world, but the gap is going to close. I think given the undervaluation of the yen, if I was to look on a five-to-10 year horizon, the yen would have to be the currency that I would pick out.

Tim Graf: As a final question, we opened this discussion talking about the fatigue that has now set in with both of us. But I think you can extrapolate this to a market wide setting. And I'm just wondering what you think about this and how people trade in this environment and particularly their sensitivity to headline risk. So where I'm going with this is we just passed the 100-day marker for the Trump administration and no matter what your thoughts politically, it's an administration that I think almost by design creates uncertainty. That's the feature, not a bug.
But it also, I think when it comes to headlines and particularly sitting in markets creates headline fatigue.

And I'm just curious how sensitive you think markets will remain or perhaps become. Maybe we haven't seen the worst of it, I don't know. To headline risk and particularly thinking about this over the coming few months, how you expect markets to respond to political events, given what we've gone through.

Lee Ferridge: I think respond in a decreasing manner. And what I mean by that, I mean you mentioned headline fatigue, but I think we came from a point of frothy markets. We came from a point of heavily overweight pro-risk positioning.
I mean our asset class weight series showed the equity overweight compared with its long run average was at a 16-year-high earlier this year or the back end of last year. So you had heavily overweight positioning in pro risk and then we had this barrage of headlines of varying degrees of which the tariffs were front and center, but there was a whole range of headlines that impacted the market. Now we're back to neutral in a lot of positioning metrics. I think that by nature then the reaction to any new headline is more limited because people aren't left exposed by a change of direction.

I also think that as time goes on we will get more clarity on tariff position and then maybe people can start to remodel the economy and actually have a little higher degree of conviction over their macro backdrop. And then I think they're going to be more inclined to stick with their positions rather than flip them around on every headline that comes out. And I think we've had this tendency to flip around on every headline that's come out.

Look at the moves you alluded to in the equity market. I don't know what we are the 14, 15 percent off the lows that we saw a few days after Liberation Day. I mean, these are ridiculous numbers in terms of size of the moves we've been seeing in equities. We're not going to see that repeated from here on in. I think, I don't think positions over the next year or so are going to get anywhere near as extreme in one direction or another as we were coming into this year. That dampens down the reaction to headline risk. And I think over time people will get a little bit more comfortable with reasserting their macro conviction and that would allow them to position smaller size. But I think the actual flipping around on every headline, I think that's going to, that's going to be much, much reduced. And we're already starting to see it and I think we'll continue to see that.

Tim Graf: So selling may and go away or just go away.

Lee Ferridge: I didn't just go away at the moment.

Tim Graf: Very good. Let's go away then. Thanks Lee.

Lee Ferridge: My pleasure.

Tim Graf: Thanks for listening to Street Signals. Clients can find this podcast and all of our research at our web technical Insights. There you'll be able to find all of our latest thinking on markets where we leverage our deep experience in research. On investor behavior, inflation, media sentiment and risk. All of which goes into building an award winning strategy product.

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