Thinking Through Structural Change
Equity markets are coming off a week where the major averages are pressing back up against record highs, interest rates settled down after hotter-than-expected inflation data, and the U.S. dollar is at the lows for the year. This breakout to a new all-time high in the S&P 500 above 6,100 is tentative at best and occurring with divergences abound. On days when equities have been rallying volume has been waning, and breadth has been lackluster. The price action is neither exciting nor concerning but rather speaks to the range-bound nature the S&P 500 has found itself in since just after the elections last November – bound by 5,900 on the low side and 6,100 on the high side.
There is also a bit of a lopsided nature to this market in that the equal-weighted S&P 500 index lagged the cap-weighted metric by less than half last week, with economically sensitive areas performing rather poorly. Couple this with bond yields holding steady even in the face of higher inflation readings, and you have what looks like an equity market beginning to discount a slower GDP growth profile ahead. Perhaps later this year, we’ll look back at the markets today and conclude that the swaps market pricing in just one Fed rate cut for 2025 as being as offside as the seven rate cuts it was pricing in for all of 2024 back at the start of 2024.
As for the bond market, the yield on the 10-year T-note appears properly priced around the 4.50% level, given the wide array of outcomes for both the economy and inflation over the next twelve months. In my estimation, the biggest risk for asset prices over the next six months is a further persistent push higher in inflation – the below chart from BofA provides a good roadmap for the various paths inflation could take based on upcoming monthly CPI prints.
In the meantime, asset prices, in general, are holding firm and taking the headlines coming out of the new administration in stride. Helping with this support are stable interest rates and a U.S. dollar that just recorded its first weekly lower low since September, along with a lower high earlier this month. The technicals suggest that a top formation is underway for the U.S. dollar, which would be a significant development for asset prices if this ends up getting confirmed. Perhaps this is another tailwind pushing gold to new all-time highs as the yellow metal just posted its seventh straight weekly gain – its longest streak since the Summer of 2020.
The chart below plots the move in gold since mid-December and illustrates the rather steep ascent its taken so far in 2025. The last couple weeks (green box) highlights a bit of digestion that’s been playing out. For long-term gold bulls like myself I’d prefer to see a bit of breather here and a cooling of some of the froth that has recently entered the market, but there is more to this move in gold than meets the eye, as I’ll get into a bit deeper below.
Moving beyond the short-term set-up for asset markets, humor me as I attempt to script out a narrative for some of the structural changes I see potentially shaping up with the moves and comments coming out of this administration. Let’s start with tariffs and the lens through which this administration views them as both a tool for leverage and revenue. I listened to a very thought-provoking and insightful podcast last week between Erik Townsend and Jim Bianco on MacroVoices: The Mar-a-Lago-Accord (I encourage everyone to listen to it). Below I’ll do my best to sum up the conversation:
The Trump administration is viewing the $ 36 trillion in U.S. federal debt as nearing a crisis level where just saying it's unsustainable has become an understatement. As a result they will take their shot at trying to solve the issue and put it on a sustainable path. Remember that whether you agree or disagree with their solution is entirely different than recognizing and acknowledging that this is what they are going to do.
Their solution entails a three-pronged approach that could redefine global security and the existing world order:
Tariffs used as both a negotiating and funding mechanism. The idea of creating an External Revenue Service (ERS) shows a change of thinking from income tax reliance to one of shared responsibility by the rest of the world via tariff revenue.
Discussions of creating a U.S. Sovereign Wealth Fund – Treasury Secretary recently commented that this administration is interested in monetizing U.S. assets (gold, land, property…)
Restructuring Global Security where the U.S. would no longer provide military protection for allies (NATO, EU…) for free – NATO countries must pay 5% of GDP towards defense. Moreover, this administration has held discussions with other countries on a debt swap plan where foreign holders of U.S. Treasury bonds would be swapped with 100-year zero-coupon bonds. It’s this administrations way of demonstrating that no longer are they willing to put the liability of the U.S. providing global protection on the farmers and manufacturing workers in middle-America. These Americans have paid and sacrificed enough, no more – its time for the rest of the world to pay their fair share for these U.S. benefits.
Once again, don’t ‘yell at the messenger’ – I’m trying to articulate my reading of the tea leaves – whether this is right or wrong or if this will succeed or fail is another discussion.
Such an approach is fraught with potential outcomes and risks:
If successful then the U.S. debt crisis likely gets on a sustainable path, domestic manufacturing and industrial capabilities boost the U.S. economy (main street wins, Wall St. likely loses), and foreign allies begrudgingly accept the new terms of paying for security that they didn’t have to pay for in the past.
Real assets (tangible assets) like gold, bitcoin, real estate, industrials, banks, raw materials, and Technology perform well. The U.S. dollar weakens relative to real assets and U.S. export competitiveness improves.
If unsuccessful then alliances get fractured, the rest of the world more forcefully pivots to nationalism, trade wars expand, NATO and the EU seek out alternative alliances, China and Russia become stronger on a global stage, asset price volatility increases measurably, inflation increases, interest rates continue their structural climb, and the U.S. debt crisis implodes (as would be the case for all over-indebted nations around the world).
Big picture: should the administration carry through with some/all of these ideas and ambitions – we are looking at a structural shift on par with what came out of Bretton Woods in 1944 or the Plaza Accord in 1985. This would represent an end to the status quo where Trump’s “America First” economic strategy shifts global power dynamics and ushers in a debt restructuring that could either upend a budding debt crisis or accelerate it. This argues that investors should take these dramatic structural changes seriously while considering the endless potential ramifications.
What's different about this Trump term versus the last is that he has the popular vote – and the average American is on his side. The American people are tired of taking a back seat to globalism and have witnessed a hollowing out of job opportunities across the country. Whether you believe Trump is genuine or simply capitalizing on people's fears is up to you, but for now, tariffs are popular, DOGE is popular, and there's growing momentum to rework trade terms as many feel the rest of the world has taken advantage of the U.S. for far too long.
Having walked through the above thought exercise, let’s dig into the recent announcement of reciprocal tariffs by the Trump administration and whether they are a threat or support to new highs in risk assets. For starters, we saw a dramatic intraday reversal in the U.S. dollar on the day the reciprocal tariffs were announced. For starters, the reciprocal tariffs strategy is less likely to be viewed as an unfair trade policy by the U.S.’ trading partners. Understandably, there is frustration brewing as countries scramble to adjust to the idea of reciprocal tariffs.
Unlike Trump’s first term, he is handing off a lot of the work to professionals this time, and while many may dislike tariffs, there's no doubt that Bessent, Lutnick, Hassett, Stephen Miran, and others are no fools. They have a plan, and their targeted approach is winning on both the PR front and behind the scenes. When you get to the crux of it, reciprocal tariffs allow the U.S. to point out, “Hey, we are not doing anything to you that you are not doing to us,” this likely increases the odds that we see tariff rates mutually lowered in some cases.
Lower tariff rates represent less upside risk for the U.S. dollar because it reduces pressure on U.S. trading partners to devalue their currencies to maintain competitiveness in response to fresh tariffs. Put differently, a country devaluing its currency to offset well-branded reciprocal tariffs would clearly signal its intent to maintain the old world order of unfair trading practices that benefit its industries at the expense of American workers. In signing the executive order for reciprocal tariffs, President Trump promised many things to the American public, most notably more jobs and lower prices.
We can debate whether there is enough labor supply in the U.S. to support an influx of manufacturing jobs – or whether manufacturing costs in the U.S. are low enough to be economically viable even with reciprocal tariffs in place. We can also debate whether the advent of new trade frictions will lead to lower prices – after all, not every country will be incentivized to negotiate every pre-existing tariff to 0% to avoid reciprocal tariffs. On a net basis, U.S. tariff barriers will most assuredly rise after the April 1 deadline for the Commerce Department's study on trade and currency manipulation. What we cannot debate is the impact President Trump’s clever reciprocal tariffs strategy is already having on asset markets – where the perception of a globally coordinated decline in the U.S. dollar (a la Mar-a-Lago Accord) is causing investors to bid up global equities, commodities, and precious metals. Lastly, a declining dollar is an explicitly bullish dynamic for global liquidity and reduces the probability of a global refinancing air pocket late in the year.
As for the bond market impacts, the prevailing negative sentiment around the U.S. policy – and Trump himself – is clouding some investor's judgment. People are overthinking issues like whether a VAT tax should be considered a tariff, and they're worried that inflation will force the Fed not just to pause but to hike rates again. Combine that with the belief that the economy is stronger than ever, and you get an endless loop of bond selling (persistent rise in interest rates). But that's not the play anymore. Bonds are poised to perform well in 2025 for a few key reasons.
First, these reciprocal tariffs are hyper-targeted and not inflationary in the long term. Second, the rest of the world has lost the PR battle – they can no longer play the victim when a reciprocal tariff is self-inflicted. This shift in perception is why you see so much hand-wringing about them. It's not a good deal for the rest of the world, but it's not bad for U.S. bondholders. Global economies will face pressure as they're forced to adjust to these new threats, and businesses may tighten their belts in anticipation of higher costs or fees to get their products to market. This could lead to a cooling of economic activity. Importantly, my work suggests that the tariffs will largely be absorbed by currencies and producers – not by consumers – which means the result will be bearish for corporate profit margins and earnings growth but not inflationary. That creates a favorable environment for bonds and why they represent a good diversifying asset in a portfolio following three difficult years where they were either a significant drag or dead weight.
The articles and opinions in "Capital Market Musings and Commentary" are for general information only, and not intended to provide specific investment advice. Performance, dividends and other figures have been obtained from sources believed reliable but have not been audited and cannot be guaranteed. Past performance does not ensure future results. Investing inherently contains risk including loss of principle. Advisory services offered through Casilio Leitch Investments, an SEC registered investment advisor.
Copyright © 2023 Casilio Leitch Investments. All Rights Reserved.