Markets Weekly: Is US Exceptionalism Fading?

For years, the United States has enjoyed a period of economic "exceptionalism," consistently outperforming other major economies in terms of growth, job creation, and market returns. But that narrative is now being called into question, with recent market signals suggesting US exceptionalism may be facing its most significant headwinds.

Trump Trades Lose Steam

The first signs of this shift can be seen in the unraveling of the so-called "Trump trades." The initial post-election euphoria, fueled by promises of tax cuts, deregulation, and an "America First" agenda, drove a surge in US assets. But as Bloomberg reports, that optimism has faded:

A month into President Donald Trump’s second term, the euphoria is fading around many of the trades that investors piled into after his November victory, from stocks to the dollar to Bitcoin. Instead of extending the period of US exceptionalism in global equities, the S&P 500 Index’s record run has still left it trailing European, Chinese and Mexican benchmarks. The dollar’s strength and bearish bets on US Treasuries are both losing steam. Even the breathless rally in cryptocurrencies and related stocks has wilted.

Here's how the key Trump trades are losing steam:

• Small-cap: Initially seen as major beneficiaries of a stronger domestic economy and potential protectionist measures, small-cap stocks (as measured by the Russell 2000 Index) have significantly underperformed, rising only about 1% since Election Day.
• US dollar: The "strong dollar" trade, based on the expectation of higher inflation and interest rates, has faltered. The Bloomberg Dollar Spot Index, after gaining 4.5% from Election Day to mid-January, has since declined by about 1.5%.
• Yield Curve: The bet on a steeper yield curve (where long-term rates rise faster than short-term rates), driven by expectations of higher inflation and increased government borrowing under Trump, has reversed. The curve between 2-year and 10-year Treasury yields, after steepening sharply from November to early January, has since flattened, as the Treasury signaled steady bond sales and the administration vowed to cut spending, easing deficit concerns.
• Cryptocurrencies: The initial surge in digital assets, fueled by hopes for a more favorable regulatory environment, has cooled considerably. Bitcoin, after peaking above $100,000 in January, has retreated, and scandals surrounding certain memecoins have dampened enthusiasm.

Tariffs as the Primary Threat

Driving this shift in market sentiment are President Trump's aggressive trade policies. The imposition of tariffs on steel, aluminum, and Chinese goods, coupled with threats of "reciprocal tariffs" on a wide range of countries, has created significant uncertainty and raised the specter of a global trade war, argues Mohamed El-Erian:

Should they persist, such increased uncertainties risk pulling the rug from under America’s growth momentum at a time when massive spending is required on future engines of prosperity such as artificial general intelligence. They might also diminish confidence in both price and financial market stability.

Tariffs, by their nature, increase the cost of imported goods, potentially fueling inflation. They also disrupt supply chains, hurting businesses that rely on global trade networks. The National Retail Federation recently issued a stark warning regarding the tariffs’ impact:

It will likely result in higher prices for hardworking American families and will erode household spending power. We encourage the president to seek coordination and collaboration with our trading partners and bring stability to our supply chains and family budgets.

Beyond Tariffs

But the challenges extend beyond tariffs. The Trump administration's stance on immigration, its approach to fiscal policy (tax cuts vs. spending cuts), and its overall regulatory posture create additional layers of uncertainty. Businesses, facing a constantly shifting policy landscape, may be hesitant to invest and hire, further dampening growth:

Business is also having to navigate a U-turn in what were multi-decade efforts to harmonise regulations and standards across major economic jurisdictions. Such harmonisation efforts helped reduce the cost of doing business globally. Now, firms are having to navigate divergent trends on regulation, sustainability and issues like diversity and inclusion, especially between Europe and the US. (El-Erian)

This policy uncertainty is compounded by a challenging global environment. Europe and the UK face recessionary risks, while China's economic decision-making has become increasingly unpredictable. While the US has, in recent years, been the engine of global growth, the current situation raises the possibility of a synchronized slowdown, with no single economy strong enough to pull the others along:

The resulting danger is that global convergence happens the wrong way. Rather than exceptional America pulling up the sluggish Chinese and European economies, the weight of uncertainties risks pushing the US down to the other two. (El-Erian)

The Fed's Limited Options

Compounding the problem, the uncertain policy environment in Washington is making it increasingly difficult for the Federal Reserve, traditionally a key player in managing the US economy, to act decisively. While lower interest rates could help cushion the blow from a trade war, higher inflation (potentially fueled by tariffs) limits the Fed's ability to act.

Chair Jerome Powell, in his recent congressional testimony, emphasized the Fed's "data-dependent" approach and its reluctance to commit to further rate cuts, stating they do "not need to be in a hurry to adjust our policy stance".

What's Next for the US?

While the S&P 500 continues to climb, its year-to-date gains of roughly 3% pale in comparison to previous years – falling well short of the over 20% gains seen in both 2023 and 2024 – and it now trails behind other global benchmarks. This is particularly true in Europe, where the EURO STOXX 50 is up 10% year to date.

Despite the challenges, the U.S. equities continue to shows signs of underlying strength. Ellen Wang of JPMorgan notes:

First, U.S. macro data, particularly the dovish December CPI and the robust employment reports, point to a Goldilocks backdrop that continues to support economic growth reinsert: and earnings delivery. Second, earnings remain robust. With about two-thirds of S&P 500 companies reported so far, the blended earnings growth rate is at 16%, higher than the 12% expected growth rate, which is also the strongest earnings growth since Q4 2021. We continue to expect U.S. exceptionalism to play out in 2025. 

Whether the US can maintain its exceptional performance in the face of these mounting headwinds remains, more than ever, an open question.

Long / Short

Crude Oil: "A potential Ukraine-Russia peace deal and associated easing in sanctions on Russia is unlikely to significantly raise Russia oil flows... we believe that Russia crude oil production is constrained by its OPEC+ 9.0mb/d production target rather than current sanctions, which are affecting the destination but not the volume of oil exports. This rise in compliance with OPEC+ targets from Russia and several other OPEC+ producers and the option value from waiting amidst US policy uncertainty are key reasons why we assume OPEC+ will delay its gradual production increases from April to July." (Goldman Sachs)

US Dollar: "Despite its latest consolidation, the USD remains the weakest G10 currency so far this month and since the start of 2025. The underperformance has been attributed to improving market risk sentiment that has eroded demand for the safe-haven USD. In turn, the risk appetite recovery could be linked to hopes that the Trump administration would be using tariffs as a negotiation tool and could further shy away from relying on aggressive, blanket trade levies." (Credit Agricole)

AI: "We see mid-teen returns for global AI stocks this year. For global markets excluding China, we forecast total AI spending to be close to USD 500bn in 2026, the fourth year since the 'ChatGPT moment,' based on current and guided capex commitments from major tech companies. We expect AI-related revenues, both direct and indirect, to also reach USD 500bn by then." (UBS)

Quick Hits

• China Supports Private Sector: China's central bank pledged financial support for the private economy.
• UK Inflation Rise: UK inflation unexpectedly rose, complicating potential Bank of England rate cuts.
• Fed Concerns Over Trump Policies: Federal Reserve minutes revealed concerns over potential inflationary impacts of Trump's policies.
• Trump Tariffs Impact Pharma: Indian pharma stocks took a hit on news of Trump's proposed tariff plans.
• Singapore Gold Exports Surge: Singapore's exports to the US have spiked due to gold market ructions.