By Karsten Müller, Assistant Professor, Department of Finance, National University of Singapore
Investors around the world have long regarded the US financial system as the most stable, liquid and reliable in the world. But US President Donald Trump’s recent tariff announcements, repeated questioning of the sovereignty of Canada and Greenland, and bullying of Federal Reserve Chairman Jerome Powell may just be on the verge of changing that. The global spike in volatility and the sell-off in equities have been accompanied by a rare phenomenon: a “sell America” trade2 mindset, with investors dumping not only US equities but also traditional safe-haven assets, such as United States Treasury securities, leading to wild swings in Treasury yields and a depreciation of the US dollar.
The “Sell America” financial panic: How concerned should we be?
How worried should we be about this panic spreading further? A key question will be whether the current dislocations in financial markets remain confined to trading desks or whether they materially affect banks’ balance sheets. After all, the Trump tariffs and the overall heightened uncertainty will not just affect the economy through the obvious channels of lower demand, supply-chain disruptions and lower business confidence. The situation could turn out to be particularly dangerous for the macroeconomy if it also affects the banking system.
If panic hits the banks, an economic downturn often follows
As long as the panic is limited to asset-price fluctuations, the consequences may be manageable. However, much more dangerous risks lurk if panic hits the banks—either because the disruption in Treasury markets affects their access to wholesale funding markets or because it triggers an old-fashioned bank run of the kind last seen during the 2023 Silicon Valley Bank (SVB) episode.
A perhaps underappreciated fact about such bank runs is how damaging they can be even when, as is true today, banks are relatively well capitalised and have been making profits in recent years. A recent research paper studying many hundreds of bank-run episodes over more than 200 years around the world suggests that these events tend to be followed by major recessions, even when the banks were fundamentally sound.
If the panic moves from financial markets to banks, the likelihood of a major economic meltdown will increase drastically—the Bank of England is already warning of the increased likelihood of “severe shocks” to the financial system. Indeed, research suggests that a typical systemic bank-run episode can be followed by a fall in gross domestic product (GDP) of up to 10 percent over the following five years.
The unusual origins of the current panic
While temporary downturns in equity markets are nothing new—as any seasoned market participant can attest—the origin of the current one is clearly unusual. In the past, outright bear markets have often followed periods of what turned out to be excessive optimism, such as the dot-com bubble, or major financial crises. Rarely have the comments of a US president moved markets more, especially in an environment of low unemployment, robust growth and normalising inflation.
This unusual situation also makes it difficult to contemplate what might happen to the banking sector. In the past, the combination of buoyant credit growth coupled with loosening credit standards in a low-interest environment has often been a precursor to pressure on banks’ balance sheets, if not outright financial crises. However, despite the rapid growth of potential risk factors, such as the expansion in lending to providers of private credit and the increasing potential for climate-related events to affect credit losses, most observers did not foresee major risks to financial stability until recently.
A key test going forward will, therefore, be how bank creditors interpret the situation. If there is a sudden withdrawal of funding, banks have historically not been able to make up for it by raising funds elsewhere. And the resulting inevitable credit crunch may hurt businesses and households that are already starting to feel the heat from Trump’s tariff war. That is why a close look at what will happen to banks’ funding situations and liquidity positions will now, more than ever, be informative about the macroeconomic outlook, over and above any dislocations we may expect that are directly attributable to Trump’s tariff war.
A key segment to watch will be trade finance, which is facing an unprecedented challenge in dealing with the surge in global trade uncertainty. As US tariff policies have disrupted global supply chains, it has become more difficult to assess risk. This uncertainty, in turn, could lead to a tightening of credit conditions as banks become more cautious in extending trade-related finance, with potential spillovers to other segments of the market.
What bankers and regulators can do
So, what can bankers and regulators do in the current environment? International coordination has perhaps never been more important, especially now that many countries are united in trying to fend off the US president’s tariff policies, which may open up new avenues. Central banks should continue to communicate their views clearly to reduce uncertainty as much as possible and prevent panic from spreading throughout the financial system.
Regulators in some countries may also want to step in with pre-emptive commitments to provide liquidity support and stand ready to provide liability guarantees, which are some of the strongest correlates of bank runs not ending in tears. And given the potential for market panic to affect bank funding, both the private sector and regulators should closely monitor major institutions’ funding stability.
Will we learn the lessons of history?
The current financial panic is a stark reminder of the fragility of market confidence and the speed with which it can erode. History provides us with ample evidence that in a situation whereby intense panic grips the banking sector, even the most well-capitalised balance sheets may fail to provide banks with the ability to keep credit flowing, thus precipitating an economic downturn.
Policymakers have an important role to play in the current situation. They must signal confidence in the banking system to boost confidence, closely monitor banks’ liability positions and ensure transparent communication about their potential to backstop any spillovers from a market panic. Such safeguards will be critical to avoid a broader macroeconomic fallout.