Making sense of profound change is always hard. But it’s especially hard in the moment. Since “liberation day”, market commentary on Donald Trump’s tariffs has ranged from the stunned to the apocalyptic. And yet, in dollar terms, the S&P 500 is down less than 4 per cent in 2025.
Note the currency used here. For non-US investors, many of whom have benefited from years of a strong dollar and even stronger US share prices, the greenback’s sell-off has amplified the pain in equities. Even after the recent bounceback, both euro- and sterling-denominated investors in the index are down by around 11 per cent in the year to date.
A slight derating explains some of the fall. According to FactSet, the S&P started the year on 21.5 times forward earnings. It is now at 20.7, although drops in earnings per share (EPS) estimates since 28 March – 1.7 per cent for 2025 and 2.4 per cent for 2026 – suggest the recent rally isn’t backed by fundamentals.
A weaker dollar tells us something else. While untangling currency moves is always a messy business – and at the margin might even soften the blow for some US stocks’ overseas earnings – there are some signs it could point to an emerging risk premium in US assets (that is, the extra returns investors now demand to compensate for higher risks).
A year ago, Yale University’s Budget Lab released a paper pointing out how a mix of strong creditworthiness, institutions’ demand for dollars and Treasuries, economic dynamism, and legal and political stability meant the US enjoyed a “safe harbour investment premium”.
This echoes NYU professor Aswath Damodaran’s work on country risk premia, which assigns the US a “risk-free rate” against which all other countries are measured. Although this relative judgment isn’t the same as saying the US is a risk-free investment destination, the effect is similar. As the Budget Lab paper argues, this has long produced a US political risk “blind spot” for investors, disguising a growing “shadow” risk premium.
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Quantifying any risk is a challenge, and political risk is especially thorny. Still, the report’s authors found that changes in US asset pricing had already introduced a political risk premium of 25 to 35 basis points (of extra required yield) since 2016, equivalent to around half the UK’s own premium in the wake of the Brexit vote.
That was a year ago. Since then, Trump 2.0 resembles a more severe version of a scenario modelled in the report: “A serious event with sudden repricing and hit to foreign direct investment.” That hit, its author conjectures, could result in a 100 basis point increase in risk.
While talk of basis points suggests a level of precision that doesn’t really exist, sharp changes still reveal something about investors’ preferences. In the days after the tariff shock, the US-German 10-year yield spread jumped from 1.4 to 1.97 percentage points. Of course, untangling these shifts from factors such as the trade-off between safe havens and returns is never easy. What’s more, by piling on economic stress around the globe, tariffs might have increased political risks everywhere.
However, although US institutional and political risks were rising before Trump in absolute and relative terms, for some investors it’s the nature of these risks that’s changed. In his work, Damodaran distinguishes “continuous” risk – a feature of democracies’ ever-changing policies – from the “discontinuous” risks that typify sudden decision-making under autocracy or executive whim.
Faced with extreme uncertainty, corporate America’s lobbying has bought some reprieve. So far, there’s little sign of a risk premium developing in US equities. But once the dust settles, global investors may not quickly forget April’s shock.
Further reading: Political Risks to the US Safe Harbour Premium (Yale University, May 2024).
