The first few months of 2025 have witnessed a generational shift in the geopolitical and economic frame of reference. Tariff policy has understandably been the subject of the immediate focus of the investment industry, but the change goes much deeper than this. Investors might be leery about addressing this, individuals may well have very different personal views about the pros and cons of what is happening, and markets find it incredibly hard to price geopolitics, anyway. In addition, the sheer intensity and pace of geopolitical news right now might lead one to conclude that trying to allocate on that basis is simply too hard. We think this would be a mistake. What is happening is momentous and will matter for a long time. This shift doesn’t matter only for setting return expectations, but will also likely have implications for the types of return that investors require and perceptions of risk. This note is written while on the road in Asia, and questions about the risk of US assets have dominated queries from clients in meetings; we think that this will continue to be a dominant issue.
Regular readers will know that we have maintained for some time the view that investors face a “new regime,” different from the norms of the last 40 years, i.e., a time spanning the entire investment careers of most people reading this research. However, the geopolitical shift taking place now accelerates that process. A new regime is no longer some far-off-seeming place five years hence. The new regime is now.
We by no means intend to cover every aspect of the current upheaval. Instead, this note is intended as a tour d’horizon that allows us to then focus attention on a few specific areas. At its core, this narrative has the role of the US dollar and defense as two linked topics from which other aspects flow. In terms of economic variables, this in turn has implications for growth, inflation and debt. Changes to these variables necessarily lead to questions of asset allocation. There is now an additional complication: the need to consider possibly different conclusions for US versus non-US based investors. It would be of no utility at all to conclude that the world looks riskier, and hence to reduce risk in the allocation of portfolios. That might end up being one possible and logical tactical response to what is going on, but strategically investors need to take more—not less—risk in a low-real-return world. Anyway, it is no longer entirely obvious what “reducing risk” even means and what counts as a defensive asset. The better question is how best to allocate risk. More specifically, we think there remains a case for risk assets, for equities, private assets and active return streams. However, there are new near-term risks to the growth and inflation outlook. More strategically, there are urgent questions to be answered about the appropriate hedging asset to offset these pro-risk positions and whether it has changed.
The waves of tariff announcements over the last month have clearly ushered in a new economic order fundamentally different from the neo-liberal global system of recent decades. Moreover, the capricious nature of changes to those announcements with the possibility of pauses and carve-outs means that the ability for businesses to plan in the current climate has fundamentally shifted. The complaint from the left was that neoliberalism failed to distribute the benefits of globalization equally enough, while the complaint from the right was that it had left governments too powerful (even as the share of gross domestic product accounted for by profits had risen). What is replacing the neoliberal global order, so far, seems to be doing nothing to improve the distribution of outcomes. Whether it reduces the power of governments remains to be seen.
Ultimately, though, there is more at stake than tariffs. A geopolitical realignment is taking place that ends the US-led post-WWII order. As it stands today, it is not obvious at all that NATO’s Article Five still stands. In fact, it seems very likely that it does not, especially in the context of threats to the sovereignty of Canada and Greenland. The role of other multilateral institutions is also in doubt, and assumptions about the relative ordering of US allies versus adversaries have been upended. Some of this might not sound new: after all, has not deglobalization been a theme for years? Well yes, but does anyone remember that ugly neologism coined only a few years ago of “friendshoring”? The word was always horrible from an aesthetic point of view, but it seems antediluvian (literally) as a concept now. More broadly, the US, in standing back from the promotion of democracy (e.g., in some of the administration’s seemingly more positive statements about Putin and Erdogan versus negative comments about the democratic process in Europe) upends fundamental assumptions about the basis of international relations. The animus for this change seems to be multifaceted. As has been broadly discussed, it seems to stem in part from a view of international agreements as transactional and zero sum. It also seems to reflect a belief that, by supporting multilateral institutions and often acting through them rather than unilaterally, the US was not realizing the full potential of its power.
If this note has an underpinning theme, it is the concept of trust—the last two months have seen it erode. Trust in the US has been tested. This is most acute from a diplomatic perspective, with European and Canadian views of the US changed in a way that seems unlikely to be easily repaired, given the lead time for making changes to critical infrastructure. For most readers of this note, probably the most critical aspect of trust is the view that global investors take on US assets. Other aspects of this loss of trust stem from the move against certain US law firms that appear to have taken up cases that displease the US administration. Yet another aspect is raised in the questioning of whether corporate CEOs and analysts are self-censoring. Later in this note, we will come back to the question of the degree to which US government bonds and the dollar can be regarded as defensive assets anymore. But a shift seems to have occurred.
In 2022, when equities and bonds both fell, the US dollar acted as a defensive asset, arguably the only really liquid asset that protected global portfolios that year. However, its fall over the last month implies that this is no longer the case. Likewise, US government bonds have not behaved like defensive assets in a traditional way. There could be technical factors at work here in the unwinding of positions by levered investors, but also it raises the question of whether global investors have changed their attitude to such assets.
The move up in US bond yields in a risk-off environment has prompted questions of whether Trump has faced a “Liz Truss moment,” referring to the former UK prime minister. At a big picture level, sovereign risk was always going to be questioned at some point. Yes, the debt/gross domestic product (GDP) ratio has been rising for decades in G7 economies, but post-COVID, the long-term decline in interest rates came to an end, prompting questions of debt affordability. We have found that the topic has come up with increasing frequency over the last two years. What is happening seems to be more acute than simply the question of how to price sovereign risk when there is no longer a structural decline in interest rates; instead, the shift is driven by worries about how investors in such assets might be treated.
Coverage in the investment industry has been very much focused on tariff policy, which is understandable from a tactical perspective. However, when we look at this through a more strategic lens, we think that the topics of defense, the dollar, trade and debt are all very much linked. Hard military power and the dollar as the basis for international finance are two areas where the US has preeminence, from which the Trump administration seems keen to extract direct value. Debt is the potential limit to this effort. In our meetings with investors over the last year, the question of fiscal sustainability and whether sovereign risk needs to be priced into US bonds has surfaced many times. It is an important topic but does not lend itself readily to quantitative analysis, and so it does not tend to lead to an explicit call for action. Despite episodes in recent years when sovereign risk has been priced in for UK and French government securities, until recently the demand for liquid US bonds has kept any attempt to price sovereign risk more aggressively in that market at bay. This is possibly undergoing a change.
