Tim Graf [TG]: This is Street Signals, a weekly conversation about markets and macro, brought to you by State Street Global Markets. I'm your host, Tim Graf, European Head of Macro Strategy. Each week we bring you the latest insights and thought leadership from our award winning suite of research, as well as the current thinking from our strategists, our traders, our business leaders, and a wide array of external experts in the markets. If you listen to us and like what you're hearing, please do subscribe, leave us a good review, get in touch with us, it all helps us improve what we hope to bring to you. And with that, here's what's on our minds this week.

It's Liberation Day, so allow me to speak freely. I've got no idea what's coming down the pike later today in terms of the scale and scope of tariffs that the Trump administration is about to impose on US trading partners.

Will tariffs have a lasting inflationary impact or will they eat further into real incomes and contribute to a growing sense that the US economy is starting to stall out? I don't know.

So I figured it would be helpful to get some perspective on how the market reaction to trade related news has evolved so far this year and how to most effectively risk manage around events and announcements which could be pivotal in shaping the US economy for years to come or which could mean nothing at all.

Who knows? Dan Mazza, who runs our FX Forwards trading business in the US, is back on the podcast to talk to me about how he's weighing the risks and reacting to the headlines.

Dan Mazza [DM]: Okay, I'm here.

TG: Alright-y. Well, I mean the first thing I wanted to start with was actually the last couple of months since Trump really took office, maybe even a little bit before he took office, and how you perceive market dynamics as having changed with respect to how they price.

For all of these headlines that we've been getting from Trump administration officials, Trump himself, all the tariffs being put on, taken off, etcetera, etcetera.

How would you describe market dynamics in response to those phenomena?

DM: Yeah, Tim, it's a really interesting, interesting question. It's a little weird because daily ranges are so much wider, if you go back and look at like DXY daily ranges. So really trying to measure the intraday volatility, they are much wider. There was a move in March in DXY and equities, but the trend isn't or the move isn't that great.

It's really, you know, I don't want to say calm, but rather well contained. We have had a correction in equities but you know, two year interest rates, DXY, you know, really not moving.

DXY had like over 3 percent move. So there's been no clear trend other than a slight risk off move. It's really hard to gain any confidence in what Trump is saying.

Like Trump 1.0, Trump 2.0, he uses the media to negotiate. We know that tariffs are coming today, but we also know that the level of tariffs is negotiable. Yeah, yeah.

I mean market dynamics have changed and there's constant repricing of what's going to happen. But we know that it's all about negotiation. I mean, Trump comes out and says, you give us ownership of TikTok, we'll give you a deal.

Yeah, don't import Russian oil, we'll give you a deal. And it's just, this is just another part of the negotiation. It's not the end, it's just another part of this spectacle of US tariffs and in general, markets are decently behaved.

TG: Do you think some of this, and this was a theory, I think a few weeks ago when there was this barrage of headlines, tariffs being put on in the morning and being taken off in the afternoon, there was a thought that there was fatigue from all of these headlines?

Do you think it's that or do you think it is just…it's still so unknown. We can't really price for this and so we're not going to.

DM: We know the headlines are coming. Like maybe it took a week or so for people to Remember from Trump 1.0 what he likes to do and his, his tweeting or his posts on, on untruth social, like there's going to be those off the cuff comments.

We know those things are coming. But it really goes two ways. Pricing risk from a market maker's standpoint is trickier. It involves holding risk for longer and sometimes you need a wider spread for that, but it's not always possible.

Sometimes you're forced about thinking about risk in a different way. Intraday trading is really tough. You need to know your ranges, you need to know your technical levels. Technical ranges can hold up really well in this environment.

So you get a headline, you hit a technical level. Like you have to act upon that, you have to know what those are beforehand because you don't get a lot of time to trade on some of these headlines.

They've faded pretty quickly. And everybody knows the ranges, you know, and everyone's playing the ranges, you know. In the last two or three weeks it's been a range trading environment and as a market maker, you could be put into a position where you're selling at the lows and, and that's a really bad situation.

So you need to be proactive to try to minimize those types of things. And this goes to my second point about headline risk. If you want to put risk on, you need to time it correctly.

Having a well thought-out idea is, is great, but you're one headline away from hitting your stop loss. So it's really all about timing, being patient when entry levels, taking precaution, when getting into risk.

So you're getting into it slowly, averaging in. You have to have proper discipline and you, and you have to trade with zero emotion. And you can, you can argue that this is stuff that you always need to do, but it becomes so much more important in markets like this.

TG: Thinking about, we have a document we put out every week on FX execution metrics that focus on interbank activity. And you talked a little bit about spreads maybe being a little bit wider at times.

But I'm just wondering in general some of the metrics we look at in terms of volumes, liquidity, spreads and position sizing as well. Both for you in taking risk as well as maybe clients who are asking you to make a price.

Are there any generalities about those conditions that you think have changed in the last couple of months?

DM: There's been days where we've seen very high levels of volume going through the market. First of all, that's great. All the volume going through the market is great. It does show that people are trading, that people are rebalancing positions.

A lot of that is also on the back of equity rebalances. Right. So you have large moves in equities. Currency hedges are going to have to be rebalanced. So there is liquidity in the market.

From that standpoint, what issue you really get is you get some gapping markets. You get some gapping on the opens. We've seen that on the New Zealand, Sydney open their Monday morning. You're getting a lot more gaps in prices from different standpoints. And that's where liquidity is almost, is worse. Right? Because a piece of news comes out and the market reacts very quickly and there was no liquidity in that moment.

But then after that moment, where the dust settles, then there's all rebalancing that comes into the market and there's a bunch of quote unquote liquidity, so. Or quote unquote higher volumes. It's a, it's a little bit touch and go. Um, sometimes it's there, sometimes it's not. But when you have a, like a bigger move in risk markets, whether it be equities or bonds, there is some FX rebalancing on the back of it.

TG: This is an impossible question to answer, but I'm going to ask it anyway. Once we get these announcements today, the effects of Liberation Day, if you will, how would you expect this to go?

How are you thinking about this as a potential volatility event? Is a lot of news known already. Do you think, can you prepare for this?

DM: Even this isn't the end of the tariff discussion or the market's reaction to tariffs. Like, we're not going to go home tomorrow and say, like, that was fun, like it's, it's over now, like it's not the case. This is another step in the negotiation of tariffs. This is another step in a realignment of global trade. With this administration, nothing is forever.

Like everything is just another step towards what their goal might be.

And if the impact on the market is really great, we're going to have reactions from the central banks. The speed of those reactions really depends on the impact to the market.

But the central banks also understand that this is a process and they also understand that the data has to change to be able to react. Whether it's increased inflation or decreased growth, we don't really know how this is going to play out.

Either way, it's a process. Like I said, this is not the end. The market's going to continue to try to predict where we're going to end up. This is really what March was about, right?

We had a big move at the beginning of March. The market was trying to, you know, predict where we would end up and what the impact would be. And tomorrow we just realign to the new news that we get.

And then we try to predict if the impact is going to be greater than we thought or less. And will central banks have to get involved more quickly or less quickly?

It's all of that and positioning and ranges really becomes important if a position is really overdone in the market. It's going to be more vulnerable to a day like tomorrow if the news is not in favor of that position.

So it's important to know your ranges, like we said earlier, and it's important to really know the market profile. Where were the gaps in the market? What are the positions? What is the profitability of some of these trades? And really try to know the ranges.

TG: Yeah, let's get specific here then, and think about how you'd approach these coming announcements and thinking about currencies and which ranges look attractive or levels within ranges look attractive.

Which positions that you can see whether it's in our metrics of things like you know say dollar holdings or you know, positioning in US interest rate markets.

What are the best risk rewards that you think in approaching such, what could be a pivotal day, but as you say, could also just be the continuation of a process that may still go on for weeks or months?

DM: Looking at our data there's a couple of things that are starting to point out, starting to pop out to me. One of them is Aussie. We've seen a decent sell off in Aussie across G10 currencies.

So it's really you know, at a level now where I think that you would take a look at it anyway. But what we're starting to really see is we're seeing cross border equity flows really coming into the market for Aussie.

So the flows are really starting to pick up here. That's a sign that Aussie could really mean revert rally back against G10 currencies here. And we talk a lot about buy the rumor, sell the fact. Like is this your classic buy the rumor sell the fact eventually and, and, and if it is and you're kind of you know believe that risk on is the counter to this risk off move that we've had then Aussie should provide you some good value there. Either way I don't think it can stay at these levels.

The selling pressure is definitely abating and we really need a new catalyst for Aussie to continue to underperform. So without that you know the signals are telling me that long Aussie is a good trade, you know against the dollar, uh, the 200 day moving average is 4 percent higher and the dollar's weaker against most other G10 currencies. So you can really, if you want to play it from an RV standpoint there's a lot, a lot of room to make back but it's really day to day here.

Like we talk about the tariff news but you also have payrolls on Friday and that could change everything. Again you can't over commit one position. I have a post it note on my monitor that says reevaluate every day and that's really like where we are at markets right now. And it's, it's really a most, the most important thing is everything is changing every day.

TG: Yeah. Do you think you know Aussie as a is a good example of not just a first order trade war risk in that you know it exports materials to the US but of course it also exports quite a lot, a lot more in fact to China and is a second order trade war risk. And it's as you've pointed out, a currency that's been beaten up. And there are more first order currencies that have been beaten up in the last couple of months or really in the lead up to the US election. I'm thinking particularly things like Mexico prior to the election, the Canadian dollar after the election. That was a bit of a surprise in terms of bringing Canada more into the trade war discussion.

Would you also extend a more positive view to those currencies that have cheapened up quite a lot even if it is again maybe not against the dollar. The dollar as you've pointed out has also been rangy slash weak.

But would those first order trade targeted currencies maybe also be appealing?

DM: I think Canada is a little different just because the administration seems so much more focused on it from a trade partner perspective. I actually like being paid dollar rates versus received Canada rates.

I think that at the end of the day the US is a more closed economy and it is more insulated from these tariff effects than Canada. I think that's like a good RV strategy. I'm less so interested in the dollar CAD from the FX perspective. I think that's really hard to trade. That could have really big headline risk and I'd rather play it from a little bit of a lower volume perspective. One of the other things that I kind of like is Brazil Max and you mentioned Max. I've been looking in the last couple days we've had some good moves and Brazil Max carries positive from the long side and you also get that short, that short max from a tariff perspective it's really about trying to balance some carry strategies, some risk on risk off strategies and some like. It's not only diversifying your strategies but diversifying your viewpoint on the time of these trades. Like what are you willing to hold for a month, what are you willing to hold for longer, maybe for shorter.

So about diversifying all that, like from a, if you're going to go long Aussie, which is a risk, obviously a risk on strategy, I've also have some received basis trades on because I think that that's a better longer term risk off strategy that could diversify me against any immediate risk off moves. So I'm really trying to pick my spots here a bit.

TG: Yeah, well it will be difficult on the day. I can imagine that. And not wanting to run too much risk is probably understandable for the short run, the long run actually is where I wanted to take this next.

And you mentioned the reaction to tariffs from central banks. And we don't even know what the fullness of tariffs are, whether they'll be negotiated away. And of course central bankers are dealing with the same levels of uncertainty, but in starting to think about whether they might respond.

Just to get your personal opinion on this, do you think tariffs are actually inflationary? Or if they aren't, is there a time horizon at least where you might have to worry a little bit about inflation or are you focused more on growth risks and thinking about the fundamentals around this?

DM: This is the key question that we're going to ask ourselves when we get these announcements. And this is also why central banks I believe are going to have to be patient because I don't think that they, I don't think they really know what will happen between I'll say balancing inflation and balancing growth, right? Like you're in a possible situation where you're going to see higher inflation from tariffs and you're also going to see lower growth. Also one of the key things is are these both, both effects, are they transitory or are they non transitory? Like we talked about transitory inflation before, but we could also have a transitory negative growth.

But the data is going to tell the story. Higher inflation should be transitory. We've already heard about that. I would expect the Fed to try to look through any pops of inflation and I think growth is the harder thing. Tariffs are there to force the US to produce more goods itself and to import less. “Make America Great Again” is the slogan and this is part of the implementation strategy of the administration.

Can negative growth be transitory too? Can the US find a way to produce more itself and import less and that ultimately could lead to less inflation or could lead to a higher probability of the inflation being transitory. I'm not really, you know, an economist, so it's hard for me to say that I'm just going to follow the data and listen to the Fed.

One thing I really like to do to try to get the like inside look at what the Fed is thinking.

All the regional bank blogs are really good and it's almost less about what they say. But like why are they researching that topic? Like what is going on behind closed doors at the Fed that's making them go and research a specific topic and I think like that's an interesting like way to look and to see what the Fed is thinking. And all these regional banks doing their research like what are they thinking about? What are they researching? Like what tool do they not have already that they're developing to try to monitor some piece of the economy? And I think like I'll look for little signals like that.

TG: Yeah, I mean, that certainly was the case in his first administration. They did a whole set of analysis what a 15 percent universal tariff would mean, what would happen if they reacted to it, what would happen if they didn't react to it.

So, yeah, interesting to see what sort of work this all brings about. I suspect a rehash of that work to for starters, just to finish, there was a question that came up or a discussion that came up in one of our morning meetings in London this morning.

And you alluded to this a little bit in the sort of make America great program, potentially meaning reshoring, importing less from abroad. The other side of that, of course, means importing less capital from abroad.

If you're closing your external balances to the rest of the world, well, the need for you to import fixed income and equity market capital especially is also lessened. And the question then is, does this represent a more meaningful shift in your view from the trends we've had for the last, well, really since the late 1990s where the Clinton administration adopted a strong dollar policy. That was when these large current account deficits really started to grow and be sustained.

Do you think that on a very long term horizon, we've now broken that regime meaningfully enough that the US is no longer as much of a go-to destination for capital as a consequence of these factors?

DM: I'm not really sure. Again, this is a process, right. The Trump administration is trying to realign global trade. We don't know exactly how that's going to end up and we don't know exactly what the negotiating chips are going to do. Right. So I think at the moment it doesn't really change where we're at.

I think the US is still a place of investment that foreign investors really need to have in their portfolio. Whether that's from a benchmark perspective or whether that's from just an overall general exposure perspective, like they need to have exposure to US Markets, whether that be equities or whether that be bonds.

It's still the least dirty shirt type of argument. People are still going to be buying Treasuries, people are still going to be buying US Equities. So I don't necessarily think that goes away in the short term. Maybe in the long term that starts to change. The dollar is going to have some sort of reaction here, like Trump does want to realign growth and the dollar is going to react in some way.

Whether we've seen that already with the dollar sell off, I would think that we're still undecided in the markets and we're still only pricing things that at probability levels, not at a final, final destination.

TG: If you had to pick a destination for the dollar long term, do you think this represents a structural trend towards weakness or you know, based on some of the things you said about asset markets, does it not really change anything long term?

DM: I don't think it changes much long term. I mean, I think that you talk about the dollar specifically, like, okay, against what currency? I think that's what really matters. You know, we talk about here, you know, yes, the US is going to import a lot less, possibly like that's going to affect other countries too. Do other countries have the domestic demand to pick up for that? I really don't know. And like if the world just decides, okay, like we're going to realign everything else and just not include the US like maybe, but are those demands from other countries really going to fulfill that?

I really don't know. It's hard. Like I said, I'm just going to really follow the data. I really don't think it's a long term trend. It might be a tool that the administration is using to realign things. But everything is temporary. The Trump administration is temporary. Although it's for the next four years, I think everything will change. So in the long term, no, I think that the dollar is still a favored place to be for investors.

TG: Everything is temporary would make a very good other post it note. In fact, it's not too far off from the one that you mentioned. I think that's, that's, that's about right. Reevaluate every day. Everything is temporary.

Dan, good luck when this all happens. Thank you so much for taking the time to talk through your thinking on this and, and walk us through how markets are dealing with this.

I really appreciate it and as always, great to catch up.

DM: Thanks a lot, Tim. Thanks for having me on.

TG: Thanks for listening to this week's edition of Street Signals from the research team at State Street Global Markets. This podcast and all of our research can be found at our web portal, Insights. There you'll be able to find all of our latest thinking on macroeconomics and markets where we leverage our deep experience in research on investor behavior, inflation, risk and media sentiment, all of which goes into building an award winning strategy product. If you're a client of State Street, hit us up there at globalmarkets.statestreet.com and again, if you like what you've heard, subscribe and leave a review. We'll see you next time.