Unsettling but Not Fatal…

The spectrum of economic forecasts for the economy and financial markets ranges from robust to bust. Most of the differences of agreement pivot on whether Trump’s polices will bring growth or put us into recession. The facts, so far, appear to be that the economy continues to look resilient with inflation falling, unemployment holding steady, and companies making their earnings. The wildcard is what affect tariffs will have on prices and will the Artificial Intelligence era aid or hurt employment?

Of course, the Big, Beautiful Bill (BBB) Congress is working on passing to stimulate growth will increase US debt levels. If Japan is any indicator, higher debt will not yet be a problem for some years to come as countries are not foreclosed upon; they simply must strike the right balance between making credit available and monetizing their debt issuance. Previously, with Quantitative Easing the Fed bought mortgages and corporate debt from banks to provide ample liquidity and held the debt on their balance sheet. While doing more of this again would be untenable, the Fed can lend to and bail out banks, insurance companies and hedge funds to prevent financial crises—and is likely to need to do so. But looking at the probabilities going forward and ignoring wealth inequality, and the failure to raise revenue rather than continue spending, there seem to be four potential outcomes:

  1. The World economy continues to Grow because the trade war is settled
  2. The World economy falls into Recession but the US fairs best
  3. The rest of the World Grows but political division harms US growth
  4. The World economy Grows and with it the US excels

The US financial markets will likely continue to be volatile until a clear fact pattern is evident, yet three out of four of these outcomes are favorable for holding US assets. This is especially true comparing the relative size of US tech companies versus European countries’ tech titans. With Artificial Intelligence being the next industrial innovation, the US is also best positioned to lead this epoch as well.

Historically the stability and liquidity of dollars for trade has kept the dollar strong and created widespread demand for US treasuries. The Federal Reserve’s support of Eurodollar Swap Loans to provide a backstop to countries issuing loans to be repaid in dollars has also increased the dollar’s use. US stature and adeptness managing the world’s reserve currency has kept our borrowing costs low, allowed us to run endless deficits, and attracted buyers with surpluses in trade to buy US assets including stocks, bonds, and real estate. These facts ensure the dollar will not be easily de-throned as the world’s reserve currency for many, many years to come although other countries may trade with their own currencies or a new digital currency.

We continue to be vigilant because there are many moving parts to consider. Following President Trump’s Liberation Day tariff announcement, stocks and bonds both initially fell in price while bond yields began to rise with the 30-year bond topping 5.1%. Year-to-date the dollar has lost 9% of its value against other currencies and gold is rallying. Normally, bonds are a safe haven asset when stocks decline as greater demand for bonds reduces their Yield. Instead yields on long-term bonds are rising, which typically would increase the dollar’s attractiveness, pushing it higher. These unexpected outcomes are atypical correlations, but not depression looming events. Our greatest concerns are reaching a consensus on reorganizing international trade and the fallout we expect with foreign money invested in US assets being repatriated. Trump’s policies and continued deficit spending suggest we’ll see a weaker dollar as does financial repression to deflate our debt to pay it back in cheaper dollars. Foreign holders of US assets face a triple-whammy if the dollar falls, their currency rises, and they sell to take profits. This is very likely to happen despite favorable US growth due to their need to fund NATO and spur growth at home.

We are closely watching bond yields and US treasury auctions. We expect longer maturity treasuries to rise in yield as few investors want to lend savings for 10, 20 or 30 years at puny rates of interest when their purchasing power at maturity will be lower. Our expectation is for a continued rise in US stocks in the near term spurred by the BBB, and then higher bond yields in Q3 & Q4 as the US must entice $1 trillion in treasury purchases. Normally this happens with a bit of fear-fanning by the media. This scares investors out of stocks and into bonds getting the job done.