A temporary easing in trade tensions and a more benign global backdrop drove stronger market performance in May. However, beneath recent optimism lies a complex macroeconomic picture, with persistent risks related to fiscal sustainability, bond market fragility, and geopolitical tensions—particularly in the US.
Introducing the TACO trade
Risk assets rose strongly in May as global markets welcomed trade deals and de-escalations. Dubbed the “TACO trade” (Trump Always Chickens Out), this rally reflects our observations that Trump tends to reverse extreme measures when they threaten meaningful market damage. However, we are not out of the woods yet. U.S. and European Union (EU) trade negotiators are preparing to engage in critical discussions to resolve escalating tariff disputes. Currently, we face a potential increase in the effective US tariff rate from 1.5% before the election to 16.4%. This increase would effectively function as a consumer tax, fuel inflation and constrain global growth.
One Big Beautiful Bill may not be so beautiful
Meanwhile, the “One Big Beautiful Bill” is making its way through US Congress, and even with modifications, will significantly impact US debt dynamics. The legislation will reduce taxes more than spending, while diluted tariffs are unlikely to generate sufficient revenue to offset tax cuts. Additionally, spending reductions targeted under Musk’s Department of Government Efficiency (DOGE) have fallen well short of expectations, achieving less than 10% of projections, and offering little fiscal relief.
The fiscal outlook for the United States continues to deteriorate, with the base case projecting the budget deficit to rise above 6.4% of GDP in 2024 and remain over 7% for the next decade. This would push US debt-to-GDP ratios well beyond the previous post-WWII record high. While determining the bond markets’ threshold for an acceptable debt level remains extremely difficult, many market participants remain relatively unconcerned. This is likely due to the fact that concerns over rising US debt have persisted for many years without triggering meaningful market dislocations.
At present, the debt burden appears manageable, largely because bond yields remain below the rate of GDP growth. However, if bond yields begin to rise above the GDP growth rate —potentially triggered by investor concerns about overspending—the government could be forced into fiscal consolidation involving significant tax hikes and spending cuts. Such measures would likely be negative for both GDP growth and broader US market performance.
Trade war dynamics are also adding pressure to the bond market. The US, with its persistently low national savings rate and ongoing trade deficit, remains heavily reliant on foreign capital to finance its deficits. In a global environment of rising geopolitical tensions, demand for US dollar assets may diminish, even if the dollar’s status as the world’s reserve currency is not imminently threatened. Protectionist trade policies that dampen US growth prospects could further reduce foreign appetite for US Treasuries, putting upward pressure on bond yields.
In the near term, the US market will be supported by a weaker dollar and lower oil price, which could provide some relief to growth and corporate margins. However, the tail risk of rising bond yields is growing. This not only poses a direct threat to bond valuations but could also weigh on equity markets by undermining earnings growth expectations, particularly if fiscal tightening becomes unavoidable.
SA assets find support
South African assets benefited from a more constructive global environment in May, with additional local support coming from the finalisation of the national budget and a surprisingly cordial meeting between the South African and US presidents.
South African bond yields continued to trend lower over the month, aided by falling inflation expectations. Sentiment was also buoyed by the South African Reserve Bank (SARB) and National Treasury’s indication of a longer-term intention to lower the targeted inflation rate from 4.5% to 3%.
Moody’s post-budget commentary reflected a marginally more optimistic view of South Africa’s fiscal trajectory, despite the agency’s continued warnings about the risks posed by weak economic growth, South Africa’s political uncertainty, and elevated social spending. Unfortunately, the budget still reflects worryingly low levels of fixed investment when compared to global standards—a constraint on long-term potential growth.
Despite these structural challenges and muted near-term growth expectations, SA equity valuations remain attractive, with a number of listed names offering compelling opportunities. From a fixed income perspective, the narrowing spread between South African and US bond yields, combined with the growing tail risks around rising global interest rates—particularly in the US—reinforces the case for maintaining a low duration bias within bond portfolios.
