2025-01-19 15:59:21
Next week will be crucial for markets as Trump is set to announce (or disappointingly not announce) tariffs.
In this piece I will highlight the rationale behind my base case scenario and its impact on markets.
Before we do that, I want to share something with you.
I am offering a FREE trial to my institutional macro research service!
The service includes:
Multiple macro research pieces per week;
Timely coverage of important events and market implications;
Direct access to me
If you are a HNW private investor, a family office or an institutional investor feel free to request a free trial using the link below:
FREE Trial to Alf's Institutional Macro Research
And now, back to the article.
The biggest risk Trump runs with tariffs is a bond market insurrection: if investors perceive inflation as too high, tariffs can generate an injection of risk premium that launches bond yields to the moon.
In turn this would tighten financial conditions, slow down the economy, hamper Trump’s plans to reduce borrowing costs for the US, and just make him quite unpopular (people hate inflation spikes).
Luckily for him, the recently released inflation report suggests core PCE is trending at 2.3% - not bad:
Additionally, the latest job market report was encouraging and the control group of retail sales is running at 5.4% - around 2018 levels, when the pre-pandemic economy was considered strong. The economic momentum and a 2.3% trend in core PCE inflation provide Trump cover to go big on tariffs.
As the Fed hiked rates, all other Central Banks around the world merely followed the same strategy. The big issue here is that not all economies were equipped to handle such an abrupt increase in rates.
After the GFC, the US economy has deleveraged its private sector – private debt to GDP is down in the US. The US private sector also borrows mostly on fixed rate for long tenors (think about 30-year mortgages). The US also issues bonds in the global reserve currency, so bond vigilantes are unlikely to go after the US.
But what if another economy had high private sector debt, or upcoming refinancings, or floating rate mortgages and corporate borrowing which makes the passthrough of rate hikes fast and furious?
In that case, the economy will prove quite vulnerable to a prolonged hiking cycle.
The BIS just updated their private sector Debt Service Ratio (DSR) for H2 2024 – this snapshot allows us to verify in which countries households and corporates are under pressure from a prolonged hiking cycle.
Red or green colors refer to how much the DSR is above or below its long-term average in that country:
Notice how Canada and China are under increasing pressure.
And it would make sense for Trump to go after them – negotiating with a weak counterpart is always better. But identifying vulnerable economies is not only about the Debt Service Ratio – politics also matters.
For example, Germany is very unlevered as an economy: the German DNA prevents (for now) any proper deficit spending, and the private sector is also relatively conservative on how much it leverages.
As a consequence, the DSR doesn’t really pick up – yet the German economy is vulnerable.
Its business model of cheap energy imports and outsourcing production and manufacturing has been challenged by the pandemic, and China has made huge progress as a competitor for car exports. The German economy has taken a major hit, and people aren’t happy.
New elections are planned for February, and negotiating with a country in political turmoil is always better. From a game theory perspective Trump could decide to focus on China, Canada and Germany.
Even if Trump wants to target the most vulnerable economies, he must be careful.
Let’s take a look at the countries the US imports the most from, and in which categories of imports:
The car, pharma, oil and household/tech goods industries are by far the largest import sectors for the US. And Mexico, China, Canada and Germany the top 4 countries that exports the most volume to the US.
If Trump’s intention is to raise the most amount of money through tariffs on the most vulnerable economies, basic logic imposes equally heavy tariffs on all these 4 countries above.
But there is a risk in going huge against China from the get-go. While it’s very unlikely that Canada and Europe will protect their currencies, China could decide to do it.
And if we get 25%+ tariffs on China from the get-go but the CNY doesn’t weaken, US consumers will feel it. Higher import prices on Chinese goods without an offsetting move up in USDCNY = US consumers will take the hit out of Chinese tariffs, and not China.
Here, game theory would hence suggest Canada and Europe are the prime candidates for heavy tariffs.
Given that:
1) Soft inflation and solid growth provide cover for Trump to go aggressive on tariffs
2) To increase his negotiating power, Trump might focus on the most vulnerable economies
3) China, Canada and Europe are 3 vulnerable economies and the all export a ton to the US
4) But China can hit back via supporting the CNY = US consumers would pay for tariffs
5) Canada and Europe are not in a position to defend their FX, and they face political jitters
My base case for tariffs sees:
A global tariff rate of 10%
Additional targeted tariffs on China (phased-in monthly increase of 2.5% with no end in sight)
Additional targeted tariffs on Europe and Canada for a total of 25% to start (+ monthly increases)
If this unfolds, the market is not prepared.
Over the following 2-4 weeks, I would expect:
A) EURUSD to breach parity, and USDCAD to march towards 1.50
B) Bonds to rally at first, and stabilize after
C) An initial knee-jerk negative reaction in stock markets
If you liked this article, please share it with a friend.
And remember: I am offering a FREE trial to my institutional macro research service!
The service includes:
Multiple macro research pieces per week;
Timely coverage of important events and market implications;
Direct access to me
If you are a HNW private investor, a family office or an institutional investor feel free to request a free trial using the link below:
FREE Trial to Alf's Institutional Macro Research
Speak soon and have a wonderful day,
Alf
2025-01-05 17:26:02
Good morning, this is Alf - welcome back to The Macro Compass!
I wish you a fantastic year ahead: follow your passions, keep learning, and don’t drink cappuccino after 11am.
In this macro piece, we will cover the biggest market mover for H1 2025: tariffs.
We will also investigate what’s the most attractive asset class today.
But before we start, here is a present for you to kickstart this new year.
Early next week, I’ll publish my top 3 macro trade ideas for 2025.
If you want to:
Read my macro research multiple times per week;
Have access to my long-term macro ETF portfolio;
Receive all my tactical trade ideas (including next week’s)
You can now sign up to the premium TMC tier for 30% OFF.
For the first 30 users, 30% OFF. First come, first serve.
Discount Code ‘‘HNY’’.
Use the link below:
Now, to the piece.
What if tariffs end up being non-inflationary and negative for growth?
And what if Trump focuses on short-term painful policies first in H1, to then deliver tax cuts in H2?
Consensus isn’t ready for this.
Let’s disentangle the thought process behind the concept of ‘’disinflationary tariffs’’.
This paper from the new Council of Economic Advisor (CEA) Chair Steve Miran covers it – I’ll summarize.
The main idea is very simple.
In his previous term, the Trump administration increased the effective tariff rate on Chinese imports by 18%.
During the same time span, the US Dollar appreciated by 14% against the Chinese currency.
It basically means the after-tariff price in USD to import Chinese goods was almost unchanged.
As long as the USD appreciates, US consumers aren’t going to feel much inflationary pain from tariffs:
Yet we also know that tariffs are negative for business sentiment, investment, and growth.
Even if tariffs are phased in gradually as a negotiation tactic, the message will be clear: if you want to export your stuff in the US, you need to re-think your business model or cut your profits.
Additionally, it’s well documented that a super strong US Dollar acts as a drag for earnings growth in the US:
US companies generate about 60% of their revenues outside the US, and a strong USD doesn’t help there.
The charts above prove that was indeed the case in 1996-2001 and 2021-2023: a relentless USD appreciation (orange line down) slowly but surely weakened earnings growth (blue) for US companies.
Under the assumption that countries hit by US tariffs will accept a currency devaluation without a fight, there are reasons to believe that tariffs can be non-inflationary and negative for growth.
But can we safely assume China isn’t going to push back?
Why would China not try to stabilize their currency and export some inflation and pain in the US?
Let’s try to think this out as if we were Chinese policymakers.
We have three options:
1) Accept the hit: let the CNY weaken
2) Fight back: protect the CNY by selling down USD FX reserves, and hit back the US
3) Play the long game
I believe China will opt for 3: play the long game. And here is what I mean.
Chinese policymakers don’t face elections, but the Trump administration does – US midterms in 2026.
Rather than going for the extremes (1 or 2), China could decide to apply a long-term strategy that relies on two pillars.
A) Allow a steady CNY deval, and plug the hole with fiscal stimulus where needed
As China can afford to play the long-game from a political standpoint, they could opt for a middle ground between a full CNY devaluation and a strenuous defense of their currency by selling USD reserves.
B) Keep using ‘’middlemen’’ to dodge tariffs
We had some fun testing this hypothesis: can we show that China used ‘’friendly neighbors’’ to re-route their goods into the US as a way to circumvent tariffs?
Since the first round of Trump tariffs went live in 2018, China (and Hong Kong) now import a volume of goods in the US which is 5% lower than the pre-tariff era.
But at the same time, Vietnam + Korea + Thailand + Malaysia have all increased their trade flow with the US.
Coincidence?
Or China trying to dodge some tariffs by re-routing their goods exports to the US through ‘’middlemen’’?
Consensus is strongly positioned for tariffs to be:
A big macro event
Negative only for the rest of the world (US growth exceptionalism to continue)
Adding to inflation uncertainty in the US
I think there is space for consensus to be caught offside on all the above.
I could foresee a world where Trump phases in tariffs, China dodges most of them through middlemen countries, the anticipated inflation volatility doesn’t realize, but growth slows down because business investments are hit by uncertainty.
Given today’s pricing, the most attractive asset class in this scenario would be bonds.
Our models show that the option-implied probability for the Fed to hike (!) over the next 12 months is priced at 40%. That’s quite high, and it show the extent of hawkish pricing people pushed into the front-end of bond markets.
And not only that: the curve has bear steepened, and term premium has been injected in the long end too.
With Fed Funds at 4.25%, the bar being very high for the Fed to hike rather than cut, and 10-year yields at 4.60% (= positive carry) bonds look interesting here.
Especially if you think a strong USD will slow down corporate earnings, and that the hype about the macro impact of tariffs might be exaggerated.
This was it for today.
If you enjoyed it, please share this piece with a friend:
Finally: don’t miss the 30% discount on the premium TMC tier!
Early next week, I’ll publish my top 3 macro trade ideas for 2025.
If you want to:
Read my macro research multiple times per week;
Have access to my long-term macro ETF portfolio;
Receive all my tactical trade ideas (including next week’s)
You can now sign up to the premium TMC tier for 30% OFF.
For the first 30 users, 30% OFF. First come, first serve.
Discount Code ‘‘HNY’’.
Use the link below:
2024-12-09 22:05:32
Looking back at the 2015-2021 period when I traded bond markets at a large bank, it was quite boring.
Rates were mostly stuck around 0% at the front-end, and to make money you had to find small dislocations and monetize them with leverage hoping volatility would remain low forever.
Today, the story is different: bond markets are truly exciting.
So let’s have a fresh look at them.
Before we do that though - an important announcement.
My macro hedge fund Palinuro Capital is going live in January.
This is a dream coming true for me.
Do you want to be updated about the performance and progress of my hedge fund?
Fill in the form below and I will include you in the distribution list:
I expect the Fed to cut rates again in December.
Why?
See the chart below:
Even after the recent Fed cuts, today’s Fed Funds (orange) are still markedly above the underlying trend of core PCE inflation (blue).
The Fed is a simple animal: their dream is to have a stable labor market with predictable inflation.
And today, the main risk they see isn’t an inflation pick-up.
Instead, risk management forces them to protect the US economy against a deterioration in the job market.
Running a real Fed Fund rate (bottom chart, black) at +2% for several quarters on end is an exercise which was last performed in 2007.
I don’t think the Fed sees major benefits in running such a tight policy.
Hence, I believe they will cut rates by 25 bps in December.
But here is an argument for them to feel confident the US doesn’t need a major cutting cycle in 2025:
This chart looks at the US private sector (orange) and government (blue) debt to GDP since the 1990s.
It’s an incredibly important chart to approach US bond markets today.
The US went through two clear macro phases before today.
In phase 1 (before GFC), the US government refused to lever up: government debt as a % of GDP was at or below 60% and deficits were seen as a bad thing.
As the private sector didn’t receive any stimulus from government deficits and it grappled with declining demographics and productivity, it used leverage to achieve higher growth.
In phase 1, the US private sector was forced to lever up aggressively.
Until in 2008 excessive private debt and loose credit standards led to the Great Financial Crisis.
This kickstarted phase 2 of the long US macro cycle – the post GFC period.
Between 2009 and 2012 the US government printed money (read: deficits) to stabilize the US economy.
This allowed the US private sector to de-leverage: private sector debt as a % of GDP fell below 150%.
But this fiscal profligacy didn’t last for long: between 2014 and 2019 the US primary deficit as a % of GDP was less than -2% on average – mildly supportive for the private sector, but nothing special.
So we sat there in this limbo of acceptable GDP growth, but as neither the US government nor the private sector levered up aggressively we lived through a ‘’meh’’ US growth cycle.
Finally, C-19 hit and the game might have changed for good (phase 3).
Since 2020, US deficits have exploded and this has allowed the US private sector to de-leverage.
US private debt as a % of GDP is now the lowest since 2003 (!).
So: why does this matter for bond markets?
Because in a world with less private sector leverage, ceteris paribus interest rates can be a bit higher.
When there are less mortgages and corporate loans to refinance vis-à-vis higher nominal wages and earnings, the equilibrium interest rates at which the economy can function should be higher.
The flipside is obviously that an increasing load of government debt will have to be refinanced at higher rates.
In the US case though, that’s more manageable than for other countries due to the reserve currency status.
This is why the market feels quite strongly about terminal rates being well above 3% this time.
As per today, markets expect Fed Funds to still be at 3.50% in 3 years from now.
The most important implication for investors is this.
If the Fed embraces this new narrative, we are looking at few (if any) cuts left in 2025.
This is because if neutral rates are considered to be higher, the Fed doesn’t need to cut rates much more to achieve a neutral policy stance.
With euphoric expectations about earnings growth, nosebleed valuations and a less friendly Fed overly bullish investors might be disappointed in early 2025.
This was it for today. I hope you enjoyed this macro piece.
Please share it with a friend:
And also, don’t forget.
Do you want to be updated about the performance and progress of my hedge fund?
Fill in the form below and I will include you in the distribution list:
Have a fantastic day ahead,
Alf
2024-11-29 17:14:28
Hey, this is Alf speaking - welcome back to The Macro Compass!
Given the large influx of paid subscribers at the previous round, we are extending our big discount also to our cheapest tier - The Long Term Investor.
Here is why you should take the offer:
A) You will read my macro insights every single week (also on our mobile app!)
B) If you are quick, you get 40% OFF. Locked in forever.
C) This could be it. Next year we might close to new retail subscriptions.
Yes, you read it correctly.
As we are getting a large influx of institutional demand, next year we might be closing subscriptions at retail-friendly prices.
This is why today I am telling you: go for it.
The first 20 TMC readers who will use the code MACROFRIDAY for our Long-Term tier will get 40% OFF forever.
You’ll end up paying only EUR 239/year.
That’s only ~20 bucks a month to read my macro insights every single week.
The offer is valid only for TODAY!
Use the link below. Be amongst the 20 who get in:
Now, to the piece.
Trump is back slashing (or should we say: threatening) tariffs left, right and center.
The more gradual approach suggested by his inner circle is nowhere to be seen.
It seems like this Trump presidency will bring more volatility than the previous one.
And if you think about it, it actually makes sense.
Controlling the House and the Senate, Trump is empowered to run his last and more aggressive agenda: in Musk’s words ‘’it’s now or never’’ for implementing policies.
I feel like Trump has little to lose here, and he is calling the shots.
When it comes to markets, I believe it’s good practice to look at what happened in 2016.
The world isn’t the same, but Trump’s policies seem to move broadly in the same direction and even if history doesn’t repeat it often rhymes:
The chart at page 1 shows the Sharpe Ratio for the top 7 risk-adjusted trades in the 45 days subsequent to Trump’s surprise win in 2016.
We chose risk-adjusted returns over absolute returns to avoid giving an advantage to highly volatile assets like Bitcoin – in absolute return terms, the most volatile asset will always prevail given favorable conditions.
The 7 trades all make sense from a macro standpoint.
Stock markets and in particular small-caps and banks benefit from Trump’s economic and de-regulation agenda; yields move up as nominal growth is seen increasing; the USD strengthens against low yielders and countries hit by tariffs and Bitcoin acts as the perfect de-regulation friendly, animal spirit asset class.
Let’s now look at today.
We overlapped the 2024 performance with the 2016 performance for the top 7 ‘’Trump trades’’.
In choosing the ‘’day 0’’ for 2024 we opted for the day when the Republican sweep odds moved above 50% on Polymarket: at that point, a Red Wave was already priced as base case similar to November 9th 2016 when it was clear Trump had won.
Here is how the ‘’Top Trump Trades’’ look priced today:
Here are 3 observations from my side:
1) Trump Trades in the stock market are experiencing a milder rally than in 2016;
2) The FX market seems unimpressed too;
3) Bitcoin has front-loaded all the 2016 gains in less than half the time.
Every time there seems to be an obvious trade we should always ask ourselves why should it be so easy.
In this case: can we safely assume there is a lot of juice left in USDMXN or stocks?Has Bitcoin already run its course?
For the Trump Trades in the stock market, one reason why we are lagging behind could be valuations.
The S&P500 wasn’t nearly so expensive in late 2016 from a forward P/E perspective, and therefore a long stock position here relies heavily on earnings to deliver as valuations are already high.
In FX, I can explain USDJPY – the Ministry of Finance in Japan limits the upside there.
But why would USDMXN not trade much higher as it did in 2016?
It seems FX markets are leaning towards tariffs being used as a negotiating mechanism rather than actual sizable tariffs being imposed on several countries in the end.
I think FX markets are largely underestimating Trump 2.0 and the volatility he will bring.
But also remember that in the medium term, macro conditions >>> reaction to short-term political agendas:
The chart above broadens the perspective on Trump Trades and it looks at 180 trading days after a Trump victory became clear in 2016 and 2024.
Notice how:
- US banks and small caps almost flat-lined after the initial enthusiasm, while the S&P500 kept going
- A short 10-year bond position lost money after the initial burst
- USDMXN longs ended up losing (!) money after 180 trading days
- Bitcoin kept going vertical and the punchiest part of the rally only happened much later
In 2017, global economies exhibited a miraculous concerted global growth amidst disinflation.
When it comes to 2025, I am not so sure that should be the base case.
I think Trump 2.0 is very much focused on foreign policy, and that this time around tariffs will become an important macro theme that stays with us for a long time.
If I am right, Trump 2.0 might sacrifice some short-term growth in exchange for harsher tariffs to pressure foreign economies to ‘’rebalance’’.
The outcome would be an increase in short-term inflation expectation but coupled with weaker growth, and a Fed likely to ‘’look through’’ the inflationary threat from tariffs to protect the US economy.
If that unfolds: most financial assets suffer, bonds do ok, the USD acts as a hedge.
This was it for today, thanks for reading.
Feel free to share the piece with a friend or colleague:
Before you go - don’t forget to take advantage of the offer.
It’s valid only for TODAY!
The first 20 TMC readers who will use the code MACROFRIDAY for our Long-Term tier will get 40% OFF forever.
You’ll end up paying only EUR 239/year.
That’s only ~20 bucks a month to read my macro insights every single week.
The offer is valid only for TODAY!
Use the link below. Be amongst the 20 who get in:
2024-11-01 15:36:35
Good morning and welcome back to The Macro Compass. This is Alf writing.
It’s almost been 3 years together now - and I loved every little bit of it.
I treasure each and every supportive comment you threw at me, and vividly remember hitting 100,000 subscribers and jumping out of joy. We are now 150,000+. It’s crazy.
But.
As I run two businesses now (my hedge fund Palinuro Capital and The Macro Compass), I need to focus on my customers even more.
So today I am asking you to become one.
Here is why:
A) You will read my macro insights multiple times per week
B) If you are quick, you get 40% OFF. Locked in forever.
C) This could be it. Next year we might close to new subscriptions.
Yes, you read it correctly.
As we are getting a large influx of institutional demand, next year we might be closing subscriptions at retail-friendly prices.
This is why today I am telling you: go for it.
The first 50 TMC readers who will use the code BLACKFRIDAY for our All-Round tier (multiple research pieces per week) will get 40% OFF forever.
You’ll end up paying only EUR 749/year.
That’s ~60 bucks a month to read my macro insights almost every day.
The offer is valid only for 3 days.
Use the link below. Be amongst the 50 who get in:
Now, to the piece.
The Bond Market is saying “This Time is Different”.
The Term Premium is on the rise, and it now sits close to the highest level for the last 10 years.
But What is Term Premium?
An investor looking to get fixed income exposure can do that via buying 3-month T-Bills and rolling them each time they mature for the next 10 years.
Alternatively, it can decide to purchase 10-year Treasuries today.
What's the difference?
Interest rate risk!
Buying a 10-year bond today rather than rolling T-Bills for the next 10 years exposes investors to risks – term premium compensates for this risk.
The lower the uncertainty about growth and inflation down the road, the lower the term premium and vice versa.
Uncertainty is the key word here!
The higher the uncertainty about future growth and inflation, the higher the term premium.
The left chart below shows how term premium (y-axis) increases with a higher dispersion of forecast (read: uncertainty) for inflation (x-axis):
Today the estimates of the US Term Premium have moved higher and they are now testing the upper side of recent ranges: in other words, there is some more uncertainty being priced in about the path ahead for growth and inflation.
Investors are less confident about a future of predictably contained inflation and growth, and they expect some more volatility and uncertainty down the road.
As we approach US elections, bond markets are telling us - yes, “this time is different”.
Persistent fiscal deficits regardless of who wins US elections can lead to more volatile inflation backdrops, and to more boom/bust cycles.
But as Term Premium is on the rise, should we fear the return of Bond Vigilantes?
Not so fast.
This week, Bond Vigilantes are in action in the UK: the fiscal budget unveiled by the new UK government has been assessed as ‘‘too loose’’, and therefore investors are going after all UK assets - they are selling GBP, selling UK bonds, and even stocks.
Bond Vigilantes are truly in action when they initiate a sell-off in bond markets to impart discipline to policymakers, and they hence generate a spill-over effect to the currency and potentially stock markets too.
But the US is not the UK.
Over the last 40 years, Bond Vigilantes have NEVER been in action in the US:
Over the last 40 years, we never really had investors puking on US assets - true Vigilantes are in action when both bond yields go up, and the USD goes down.
As you can see from the chart, that quadrant is basically empty.
We are instead experiencing people pushing US yields higher and the USD getting stronger. The bond market is hence sending a different message.
''Trump's policies will be stimulative for nominal growth, and the US will grow faster than other countries''.
Additionally, investors are hedging for a scenario in which rates move up fast via options. This is evident in the so-called ''skew'':
This means investors are willing to pay more for bond puts than for bond calls for the next month.
This is unusual: investors normally pay more for ''insurance premium'' (bond calls) than for puts, so this is related to election hedging.
There are no ''Bond Vigilantes'' in action here.
Instead, the bond market is preparing for a Trump victory and for policies that will be stimulative for growth and inflation.
Yet, history shows us this.
Elections are a powerful short-term volatility event.
But macroeconomic cycles tend to prevail over time.
Trump was the President in 2019 as well, but as the global macroeconomic cycle was weak 10-year Treasury yields traded as low as 2%.
If Trump secures a sweep, I expect the bond sell-off to accelerate.
Your mother and your dog will tell you to sell bonds at 4.50% yields.
That’s when you should consider buying them instead.
And don’t forget: today you should go for it.
The first 50 TMC readers who will use the code BLACKFRIDAY for our All-Round tier (multiple research pieces per week) will get 40% OFF forever.
You’ll end up paying only EUR 749/year.
That’s ~60 bucks a month to read my macro insights almost every day.
The offer is valid only for 3 days.
Use the link below. Be amongst the 50 who get in:
Enjoy your weekend,
Alf
2024-10-20 23:33:12
The key macro event of 2024 is approaching: US elections are around the corner.
Next week I will release a deep research piece on US elections, which will be centered around the key questions looming large.
How to trade different scenarios?
What happens to markets if Trump secures a Red Sweep?
And what asset classes to prefer if instead Kamala wins?
This special election piece will be ONLY available to my private distribution list.
Sign up for FREE here:
Macro clouds remain on the horizon.
Wherever you look at, you see unsustainable economic models: we are either relying on debt-fueled growth (US), trying to squeeze exhausted growth models (China), or succumbing to a slow and painful death (Europe).
Today, let’s take a step back and talk about the business models that Europe and the US are pursuing.
Let’s unpack them together, and understand what lies ahead and how to prepare portfolios accordingly.
Europe is slowly dying.
To prove my point, here is one of the most depressing chart you'll see today:
The chart above shows an uncomfortable truth for Europe.
ECB's Professional Forecasters now expect 5-year GDP growth in Europe to come in at only 1.3% - the lowest level ever.
Prior to the Great Financial Crisis, this number used to be consistently above 2.0% in real terms.
So while we are talking about the ''Roaring 20s'' for the US, and while we are watching countries like India perform particularly well we are left to answer some tough questions in Europe.
Why is growth so low, and expected to remain so sluggish?
1️⃣ An imperfect European infrastructure, and no improvement in sight: we run a ''union'' under one monetary policy, different fiscal policies, and without a banking or capital markets union.
2️⃣ Poor productivity, and no structural reforms: while touted the whole time, European politicians are really not busy with reforms to structurally improve productivity.
Over the last 20+ years, European productivity growth has been a meagre ~1% per year.
The US is becoming increasingly more productive at a much faster pace:
3️⃣ Bad demographics, and worsening;
Low birth rates imply that Europe will see its labor force shrink by 25% (!) over the next 20-30 years:
Not only that - it’s also a matter of putting people to work in the first place.
In Italy, women labor force participation rate is not even at 60%.
4️⃣ No appetite for true innovation, and instead an insatiable appetite for more and more regulation
Europe is slowly dying.
Yet markets are still in La-La Land.
This week, the ECB cut interest rates once again but nominal rates remain still too high versus the underlying trend in inflation.
As the chart below shows, Europe instead needs interest rates below (!) the level of inflation to have a monetary policy loose enough to stimulate at least some growth:
The chart below is another way to picture this inconsistent bond market pricing.
The long-run equilibrium nominal rate represents the nominal interest rate that allows an economy to operate smoothly and deliver its potential growth rate while inflation hovers around 2%.
Think of it like the interest rate which ‘‘balances’’ the economy.
Prior to the pandemic, the average pricing for the long-run equilibrium nominal rate in Europe was +0.5%.
Today, it’s over +2.0%.
What has changed in Europe so that the economy can structurally handle higher interest rates way better than before the pandemic?
In my opinion: nothing.
If anything, things look a bit worse now:
Patient Europe is dying.
Better make sure your portfolio is prepared for it.
Let’s chat about the US economic model now.
Here are some staggering statistics about the US economy - since mid-2020:
1) US nominal GDP has grown by ~7 trillion
2) US total debt has grown by ~8.5 trillion
Debt-fueled economy, debt-fueled growth:
Look at this excellent chart from E.J. Antoni.
It shows how US nominal growth (blue) has increased less than the increase in federal government debt (red).
If you add in private sector debt, the red bar crosses the 8 trillion mark.
Should we worry about this debt-fueled growth model?
Look: our monetary system is centered around debt/credit creation to sustain economic growth. There is nothing inherently bad about that, but the key is to use new debt to fund productive investments and reforms.
We got worse and worse at that:
As the chart above shows, for every new $ of debt we end up creating way less than a new $ of GDP growth!
So: yes, the US economy has done incredibly well since 2020.
But more than organic growth, this is once again debt-fueled growth.
Whoever wins the US Presidential Elections, you can rest assured there will be more and more debt creation to try and fuel US economic growth.
Can this model continue to thrive?
I’ll cover this in next week’s flagship US election research piece.
You can only access it registering at the link below.
It’s FREE.
Don’t miss it - register at the link below:
This was it for today.
I am counting on you to share the article with friends and colleagues so we can make The Macro Compass newsletter grow:
Thanks for your support, and enjoy your Sunday!