ORLANDO, Florida, May 27 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist

Reasons to be cheerful

A tariff reprieve from U.S. President Donald Trump, a

surprise bounce in U.S. consumer confidence and a slide in

government bond yields sparked a rally across most markets on

Tuesday, particularly U.S. assets, with Wall Street, Treasuries

and the dollar all outperforming.

In my column today I look at how much the dollar may need to

fall if the Trump administration is to succeed in making a

significant dent in the U.S. trade deficit. More on that below,

but first, a roundup of the main market moves.

If you have more time to read, here are a few articles I

recommend to help you make sense of what happened in markets

today.

1. Long bond blues stress the 'bedrock': Mike Dolan

2. Japan to consider trimming super-long bond

issuance,

sources say

3. Japan net external assets hit record, but

surrenders

world's top creditor spot

4. Investors see worsening US deficit outlook as tax

bill

heads to Senate

5. Brussels seeks companies' US spending plans as

Trump

hails move toward talks

Today's Key Market Moves

* Wall Street has its best day in two weeks, with

the S&P

500 snapping a four-day losing run to gain 2% and the Nasdaq

rising 2.5%.

* Every sector on the S&P 500 rises. Consumer cyclicals lead

the

way, up 3%, as investors bet on stronger growth.

* Japan's 30-year bond yield slides 16 bps, its

biggest

fall since August 5 last year, one of its largest ever. The

40-year yield's 25 bps fall is a record.

* The 30-year U.S. Treasury yield slumps 9 bps, its biggest

fall

since April 4.

* The dollar index rises 0.5%, driven by the

greenback's

1% rise against the yen, its best day in two weeks.

Japan spreads long bond relief

Global liquidity returned to more normal levels on Tuesday

as UK and U.S. markets re-opened after the long weekend, and

investors mostly scooped up whatever they could get their hands

on.

There were good reasons to feel bullish: President Trump

extending his deadline for imposing 50% tariffs on European

Union goods to July 9, relief at the long end of the Japanese

Government Bond market, and a spike in U.S. consumer confidence.

There will be more back-and-forth in Trump's tariff

pronouncements in the weeks ahead, and there is a case to make

that each positive turn will deliver diminishing returns for

markets. The next big deadline is July 9, when Trump's pause on

his reciprocal tariffs with the rest of the world also expires.

Similarly, consumer confidence in the U.S. and elsewhere is

liable to be volatile, difficult to predict amid such heightened

uncertainty, and susceptible to the tariff headlines of the day.

That said, if Trump's tariffs deliver a one-off price shock

and no lasting inflationary pressure beyond that, consumer

confidence may continue to improve. Economists at Citi, for

example, forecast year-end inflation of 3.2%, not too much

higher than the current rate of around 2.5-2.7% and well below

some of the gloomier forecasts of 4% or higher.

Perhaps the most interesting market moves of the day came

from Japan, where ultra-long JGB yields clocked some of their

steepest one-day falls after sources told Reuters the Ministry

of Finance may consider trimming issuance of long-dated paper.

These yields had last week spiked to record highs on growing

jitters about Tokyo's deteriorating public finances and an

alarming drop off in investor demand. Tuesday's rally in JGBs

spread to long-dated U.S. bonds, which have also come under

heavy selling pressure on concerns about Washington's fiscal

indiscipline and drawn weak demand at auction too.

Analysts at Morgan Stanley on Monday recommended going

outright long on 10-year Japanese Government Bonds at 1.505%,

which was the yield's high that day. But they remain more

cautious on the long end, despite Tuesday's rebound.

A more "lasting solution" to the recent market turbulence,

they argue, will require an increase in Bank of Japan purchases

or less supply from the Ministry of Finance. Or both.

Looking ahead to Wednesday, the global session will kick off

with an expected interest rate cut in New Zealand, span a

40-year bond auction in Japan and a five-year note sale in the

United States, and wrap up with chipmaker Nvidia's quarterly

earnings after the Wall Street close.

Historic dollar fall needed to eliminate US trade deficit

If the United States is to significantly reduce or, whisper

it, eliminate its trade deficit, the dollar will probably have

to weaken a lot. How much is unclear, though, as history shows

large dollar declines are rare and have unpredictable

consequences for trade.

Reducing the U.S. trade deficit is the key goal of Trump's

economic agenda because he believes it reflects decades of other

countries "ripping off" America to the tune of hundreds of

billions of dollars annually.

Stephen Miran, chair of the Council of Economic Advisers,

published a paper in November titled "A User's Guide to

Restructuring the Global Trading System" in which he argued that

the dollar is "persistently over-valued" from a trade

perspective. "Sweeping tariffs and a shift away from strong

dollar policy" could fundamentally reshape the global trade and

financial systems.

If a weaker exchange rate is the Trump administration's

goal, it is on the right track, with the greenback down nearly

10% this year on the back of growing concerns over Washington's

fiscal trajectory and policy credibility, as well as the end of

"U.S. exceptionalism" and the "safe haven" status of Treasuries.

But it is good to remember that a 15% fall in the dollar

during Trump's first term had no impact on the trade deficit,

which remained between 2.5% and 3.0% of GDP until the pandemic.

Making a dent in the U.S. deficit will therefore require a much

bigger move.

WEIGHT OF HISTORY

Reducing the trade deficit will be a challenge, eliminating

it without a recession, a historic feat. The United States has

run a persistent deficit for the past half-century, as

insatiable consumer demand has sucked in goods from around the

world and voracious appetite for U.S. assets from overseas has

kept capital flowing stateside.

The only exception was in the third quarter of 1980, when

the U.S. posted a slender trade surplus of 0.2% of GDP, and

trade with the rest of the world almost briefly balanced in 1982

and 1991-92.

But these periods all coincided with - or were the result of

- sharp slowdowns in U.S. economic activity that ultimately

ended in recession. As growth shrank, import demand slumped and

the trade gap narrowed.

The dollar only played a significant role in one of them. In

1987, the trade gap was a then-record 3.1% of GDP. But it had

almost disappeared by the early 1990s, largely because of the

dollar's 50% devaluation from 1985-87, its biggest-ever

depreciation.

That three-year decline was accelerated by the Plaza Accord

in September 1985, a coordinated response between the world's

economic powers to weaken the dollar following its parabolic

rise in the first half of the 1980s.

But that does not mean large depreciations always coincide

with reductions in the trade deficit.

The dollar's second-largest decline was a 40% fall between

2002 and mid-2008, just before Lehman Brothers collapsed. But

the U.S. trade deficit actually widened throughout most of that

period, peaking at a record 6% of GDP in 2005. While it had

shrunk by more than three percentage points by 2009, that was

due more to plunging imports during the Great Recession than the

exchange rate.

These two episodes of deep, protracted dollar depreciation

stand out because over the past 50 years, the dollar index has

only had two other declines exceeding 20%, in 1977-78 and the

early 1990s, and a few other slides of 15-20%. None of these had

any discernible impact on the U.S. trade balance.

DEFICIT TO 'VANISH'?

The U.S. administration is correct that the dollar is

historically strong today by several broad measures. Given that

Trump and Treasury Secretary Scott Bessent seem intent on

rebalancing global trade, pressure on the greenback looks

unlikely to lift any time soon.

But how much would the dollar have to fall to whittle away

the yawning trade deficit, which last year totaled $918 billion,

or 3.1% of GDP?

Hedge fund manager Andreas Steno Larsen reckons a 20%-25%

depreciation over the next two years would see the deficit

"vanish," while Deutsche Bank's Peter Hooper thinks a 20%-30%

depreciation could be enough to "eventually" narrow the deficit

by about 3% of GDP.

"This means that a significant reversal of the roughly 40%

appreciation of the dollar in real (price-adjusted) terms

against a broad set of currencies since 2010 could be sufficient

to get the current deficit back to a zero balance," Hooper wrote

last week.

History suggests this may be challenging without a severe

economic slowdown. But that's a risk the administration seems

prepared to accept.

What could move markets tomorrow?

* Australia CPI inflation (April)

* New Zealand interest rate decision

* Taiwan GDP (Q1, revised)

* India industrial production (April)

* Germany unemployment (April)

* U.S. 5-year note auction

* New York Fed President John Williams speaks at BOJ-hosted

conference in Tokyo

* Nvidia quarterly earnings after the closing bell

Opinions expressed are those of the author. They do not

reflect the views of Reuters News, which, under the Trust

Principles, is committed to integrity, independence, and freedom

from bias.