President Donald Trump has reportedly been infuriated by the spate of TACO, or "Trump always chickens out," jibes inspired by the President’s retreat from his initially draconian negotiating position on trade tariffs.
Slow progress towards signing trade deals has weighed heavily on the U.S. dollar, down almost 9% this year on the DXY index, which measures the greenback’s strength against six other major currencies, the loudest market warning signal about Trump’s trade and fiscal policies.
TACO Trade Hits U.S. Dollar
Global fund managers as a group have moved to their most pessimistic position on the U.S. dollar in nearly two decades, according to Bank of America’s closely watched monthly survey.
A net 38% of these asset allocators also held an “underweight” position in U.S. stocks in May, a two-year low in the BofA survey which polled 174 respondents that together oversee combined assets worth $458 billion.
Even so, the S&P 500 has more than recovered the losses incurred in the highly volatile weeks that followed Trump’s “Liberation Day” on April 2, a remarkable rebound given the apparent souring in sentiment among large institutional investors towards U.S. assets and mounting evidence of their renewed interest in European equities.
Goldman Sachs this week noted that allocations to European equities by domestic European investors “rose meaningfully in the first quarter and this trend appears to be gathering momentum.”
Debate is now boiling over whether this is just the start of a structural shift away from the U.S. in reaction to Trump’s tariffs, his territorial expansion ambitions and his demands for more military spending by European governments, which have spurred greater investor interest in defense ETFs.
Fundamental Shift
Trump’s policy announcements have resulted in a “fundamental shift” among international investors that will drive a “strong and prolonged rotation of capital from the U.S. to European equity markets,” according to UBS.
Michael Werner, an analyst at UBS in London, reckons capital inflows worth €1.2 trillion could move into European equities over the next five years as investors reduce their allocations to the U.S. stock market.
Passive index tracking strategies appear to be taking the majority of the early reallocations towards larger European stocks, which prompts the question as to how much of the projected €1.2 trillion might be captured by equity ETFs listed in Europe.
Data from the LSEG Lipper research team shows that ETFs gathered 41.3% of the €620.2 billion of inflows registered in 2024 by Europe’s fund industry, including short-term money market funds.
A crude back-of-the-envelope calculation—applying ETFs' 2024 European fund flow share to the UBS €1.2 trillion projection—could boost European ETF assets by close to €500 billion by 2030.
UBS thinks this is overly optimistic as a large portion of the €1.2 trillion of capital rotating from the U.S. to European equity markets will be directed by institutional investors who tend to allocate to segregated passive mandates rather than investing directly in ETFs.
Werner also says recent anecdotal evidence from some asset managers and various chief investment officers suggests they are looking to increase their exposure to active funds as the recent tariff-driven volatility is creating a better environment for alpha-generation.
Fund flow data will gradually provide a better picture of the breakdown between active and passive strategies with the majority of the reallocations to Europe likely to happen in 2026 and 2027 given the time required for institutional investors to review, amend and execute changes to their strategic asset allocations, said UBS.
Big Beautiful Bill Impact
The deteriorating outlook for the U.S. fiscal position, with Trump’s flagship “One Big Beautiful Bill" expected to add around $2.4 trillion to the federal government’s debt pile by 2035, could also encourage some large international investors to replace some U.S. bond holdings with European fixed-income exposures.
Strategists at BlackRock’s Investment Institute describe U.S. Treasurys as their strongest conviction “underweight.” They are watching to see if concerns about the rising U.S. fiscal deficit and proposed changes in Trump’s budget bill that have important implications for international investors drive long-term Treasury yields even higher.
Trump wants to hike taxes on income earned from U.S. financial holdings from 30% to 50% over four years for investors, companies and governments in countries that maintain "hostile" anti-U.S. tax regimes in the judgement of the White House.
The legal ambiguity around whether the $29 trillion U.S. Treasury market would be affected by the proposed tax increase is unsettling investors, according to Goldman Sachs.
The tax proposals, detailed in Section 899 of the bill, “could discourage foreign investment in U.S. assets at a time when the U.S. is seeking to reshore manufacturing and attract capital,” said Goldman.
Imposing a de facto reduction in U.S. dividends and interest payments seems inconceivably rash given the vital role played by foreign investors in funding the U.S. fiscal deficit, and proposals could still be amended in the Senate after being voted through in the House of Representatives..
But if Trump’s budget plan does become law, it would lead to a “structural reconsideration” of dollar-asset allocations, said George Saravelos, global head of foreign exchange research at Deutsche Bank.
Officials in the U.S. Treasury, asset managers worldwide and countless numbers of investors must be quietly praying that the Senate delivers another TACO for the president to digest.
This article was originally published at etf.com sister publication ETF Stream.
