Monthly Global Economic Report

Chair Powell was asked about the lack of real progress on inflation during the press conference after his opening statement. Reporter: “Chair Powell you look at the Fed's favored inflation PCE inflation and overall it's 2.1% and very close to the Fed's target. But core inflation is 2.7 percent, and it's been that way since July. So why doesn't this data give fuel to a rate pause for this meeting? Chair Powell: “The 12 month PCE is telling us is that we really have made significant progress, and we expect there to be bumps. For example, in the last three months of last year the core PCE readings were very, very low, probably unsustainably low. So that's why forecasts generally see a couple of upticks toward the end of the year. On the other hand, the January reading certainly looks like an example of residual seasonality. When that falls out of the 12-month calculation in February, we should see it staying down. So there will literally be a bump up and then down. We understand that.”

Chair Powell understands the bump higher will be followed by a drop, but most traders and market participants just look at the headline and will react if it’s up. This is why it’s important to understand his comment so we can anticipate how the markets may trade during the inflation bump higher and subsequent decline. The numbers for this discussion are in the table above.

In October, November, and December in 2023 the monthly change for those three months were the unsustainably low. As those low numbers drop off and are replaced by the monthly changes in October, November, and December in 2024, the annual change will increase.

The combined drop off PCE values for October, November, and December in 2023 are 0.1% for the Headline and 0.4% for the Core. If the Headline PCE for October, November, and December is the same as in September (0.18%), the Headline PCE could increase to 2.5% from 2.1% when it’s announced in late January. Obviously, if the average monthly change is larger than 0.18% the increase will be larger, or smaller if it is less. The Core PCE could jump to 3.0% if it increases by 0.25% in each month as in September 2024. These are big bumps. However, the bump higher should be followed by a decline in early 2025. If the pace of Headline and Core PCE inflation is maintained at the September level in January, February, and March (0.18%, 0.25%), the Headline PCE would fall from 2.5% in December to 2.1% in March. The Core PCE would drop from 3.0% to 2.5% when March is reported in late April.

If the CPI’s monthly change for Headline and Core average 0.2% and 0.3% from November through March, the Headline CPI will hold steady at 2.60% in December and then fall to 2.1% in March. The Core CPI would be unchanged at 3.3% in December and dip to 3.1% in March. The Headline number for the PCE and CPI could both be 2.1% in March 2025, while the Core PCE might be 2.5% and 3.1% for the CPI. Why is there a difference between Headline and Core inflation?

The main contributor to the sticky level in Core inflation is housing services which Chair Powell discussed in the November 7 press conference. “What's the inflation story now? I point to a couple of things. One is the non-housing services and goods, which together make up 80 percent of the core PCE index, and are back to the levels they were at the last time we had sustained two percent inflation in the early 2000s. What's not is housing services. So let's talk about housing services. Market rents and newly signed leases are experiencing very low inflation. Older leases that are turning over are taking several years to catch up to where market rent leases are. So that's just a catch-up problem. It's not really reflecting current inflationary pressures, it's reflecting past inflationary pressures.”

Chair Powell is not concerned about the current level of the Core PCE and CPI. He’s confident core inflation will be coming down since the methodology used in calculating shelter inflation in the CPI and PCE is slow in reflecting changes in current rents and leases. The lag time is at least a year and probably closer to 18 months. The title of the July 2021 Macro Tides was “Increase in Core Inflation Won’t Be Transitory” and shelter inflation was one of the reasons. “Owner’s Equivalent Rent (OER) and Rent comprise more than 41% of the Core Consumer Price Index (CPI), so changes in these categories have a far greater impact on the Core CPI than any other factor. These factors are affected by home prices and apartment rents. After plunging last year as apartment dwellers moved out of major metropolitan areas, rents have rebounded aggressively in 2021. Changes in home prices impact OER with a lag so the large increase in median home prices over the past year will gradually filter through to OER and lift the Core CPI in coming months as the Housing contribution increases in the next year.”

In June 2021 Chair Powell and FOMC members were adhering to the ‘inflation will be transitory’ narrative and likely underestimated how much the lag time in shelter inflation would lift inflation. In November 2021 Chair Powell finally conceded that inflation wouldn’t be transitory. That mistake has informed Chair Powell that the lag time in shelter inflation will be a benefit in 2024 and 2025, if real time rents and leases are included. Real time data for apartment rents is available from Apartment List and Zillow. According to Apartment List the annual change in apartment rents in October was a decline of -0.7% from October 2023 compared to an increase of 4.8% in the CPI. If the lagging methodology used in calculating the CPI was replaced with more timely data provided by Apartment List, Core CPI inflation would have been more volatile. Rather than peaking at 6.45% in 2022, the Core CPI would have soared to 11.47% as rent increases rocketed. In October 2024 the Core CPI wouldn’t be 3.3%, but 1.76% and comfortably under the FOMC’s 2% inflation target.

Since Shelter represents more than 40% of the Core CPI versus 18% of the Core PCE, the coming decline in Shelter inflation will be more pronounced in the Core CPI than in the Core PCE. Nonetheless, by mid 2025 both measures of Core inflation will be closer the FOMC’s inflation 2.0% target.

At the September FOMC meeting the Summary of Economic Projections (SEP), the Median projection showed a 1.0% reduction in the Funds rate before the end of 2024. Since the FOMC lowered the funds rate by 0.50% at the September meeting, the Funds rate projection implied a cut of 0.25% at the November 7 and December 18 meeting. The projection for 2025 indicated another 1.0% reduction in the Funds rate, which suggested the FOMC would skip a meeting between 4 additional cuts of 0.25% at the other 4 meetings. FOMC members will provide their projections for the Funds rate in 2025 at the December 18 FOMC meeting and there are reasons why the Median projection could show a smaller than 1.0% reduction in the Funds rate.

Forward Guidance

During the November 7 press conference Chair Powell was asked if President Elect Trump asked him to resign would he do so. Reporter: “Some of the president elect’s advisors have suggested that you should resign. If he asked you to leave, would you go? CHAIR POWELL: “No.” Coincidently or ironically Chair Powell delivered a speech on November 14 entitled, “Central Bank Independence and the Conduct of Monetary Policy”. During the speech Chair Powell laid out all the reasons why an independent central bank was vitally important. At the end of his speech he discussed ‘Forward Guidance” and all the ways the Federal Reserve accomplishes this including the Summary of Economic Projections (SEP). “Monetary policy works in part by trying to influence the public's view of future economic conditions, so it is crucial that these intentions are clearly communicated. Every three months, FOMC participants' projections for inflation, unemployment, economic activity, and the likely path of monetary policy are published in the Summary of Economic Projections.”

In the last 20 years Forward Guidance has had an ever increasing role in monetary policy. The Federal Reserve believes transparency will reduce surprises that cause volatility in financial markets. Treasury yields will be lower if investors have confidence the FOMC will get inflation down to 2.0%. This is why Chair Powell includes this sentence in every speech he gives. “We are committed to maintaining our economy’s strength by supporting maximum employment and returning inflation to our 2 percent goal.”

The Federal Reserve is too committed to Forward Guidance now to make changes. The best thing we can do is understand its weaknesses so we don’t blindly accept the provided ‘Guidance’ in the quarterly Summary of Economic Projections (SEP).

Economist David Rosenberg reviewed the projections in the quarterly SEP over many years and published his findings in 2022. The FOMC has gotten GDP correct less than 20% of the time, less than 25% for the Unemployment Rate, and was accurate less than 30% for Core inflation. The FOMC has total control over the Federal Funds rate and so the accuracy for the forecasts should be excellent. The FOMC’s projection for the Federal Funds rate was correct just 37% of the time. Sometimes the miss was spectacular. In the March 2022 SEP, the FOMC projected the Funds rate would be 1.9% at the end of 2022, but in December was 4.25% - 4.50%! This poor track record has diminished the Fed’s credibility.

The lack of accuracy has led many on Wall Street to second guess the FOMC’s projections. The problem is that Wall Street will usually fade the FOMC with a bullish bias. If the FOMC says it’s going to increase the Funds rate by 2.0%, Wall Street says it will be 1.50%. If the FOMC is set to lower the Funds rate, Wall Street will plan on more cuts. This tendency creates an opportunity when Wall Street realizes it wasn’t negative enough or was too positive, the financial markets have reversed trend. Last December Wall Street expected the FOMC to cut the Funds rate 6 times, which was far more aggressive than the FOMC projected. As Wall Street realized it was too optimistic, Treasury yields went up, the Dollar rallied, Gold fell, and the S&P 500 experienced a -6% decline in April.

In his Jackson Hole speech on August 25, 2022 Chair Powell said, “We are navigating by the stars under cloudy skies." Chair Powell was talking about the environment in the summer of 2022. But as the SEP’s projections show, his assessment has been applicable any time the economy is nearing an inflection point. The FOMC is reliant on data that is reported with a lag of 30 to 60 days and is often revised significantly months or even years later. The FOMC is driving the car looking through the rear view mirror, as a review of the last 3 recessions indicates. In the first estimate of GDP for the third quarter in 1990, the economy was thought to have grown by 1.6%. Six months later GDP growth was revised lower to 1.3%. Three years after the first estimate GDP was determined to have contracted by -0.9%, rather than growing 1.6%. In the first quarter of 2001 GDP was initially estimated to have grown a solid 1.9%. In 2004 it was revised to show a contraction of -0.2%. In the first quarter of 2008 GDP supposedly grew 0.5%, but in 2011 we learned it had actually contracted by -0.7%. The Federal Reserve has 400 analysts with a PhD in economics, but if their analysis is using data that is consistently revised significantly it is an example of Garbage In, Garbage Out.

Despite this history the FOMC has the hubris to issue ‘Forward Guidance’ with a straight face, which Wall Street initially takes seriously. This Achilles Heel of Fundamental Analysis is why anyone tracking trends in the financial markets must incorporate Technical Analysis to avoid being a dupe or blindsided by significant revisions.

During the press conference after the November 7 FOMC meeting Chair Powell was asked about Forward Guidance as the FOMC attempts to find the Neutral level for the Funds rate with future rate cuts. “We don't know the right pace, and we don't know exactly where the destination is. There's a fair amount of uncertainty about that. We don't think it's a good time to be doing a lot of forward guidance.”

Whether it’s a good time or not, the FOMC will provide more Forward Guidance, when it publishes a new Summary of Economic Projections after the December 18 meeting. Whatever the projections are for the Funds rate in 2025, they shouldn’t be taken as gospel, but Wall Street will. At least in the 60 minutes after the SEP is released! The September SEP projected another 1.0% reduction in the Funds rate in 2025, which is why the Median projection was 3.4%. This assumes that the FOMC will lower the Funds rate to 4.25% - 4.50% at the December 2024 meeting. The focus will be on whether the December SEP affirms the forecast for the Funds rate to be lowered by 1.0% in 2025.

Two factors are going to influence each member’s estimate for the Funds rate by the end of 2025. The primary issue is the level of the Neutral Rate, which is the level of the Funds rate that is an equilibrium level. The Neutral Rate is not contractionary or expansionary. The challenge for FOMC members is that the Neutral is a theoretical concept that can only be determined with the benefit of hindsight. This is why Chair Powell said when referring to the Neutral Rate, “We don't know exactly where the destination is. There's a fair amount of uncertainty about that.” In 1975 economists thought the Neutral Rate was above 4.0%, but the estimate has declined appreciably especially after 2000. It’s important to remember that the estimates for the Neutral Rate over the last 50 years were created well after each year and based on economic variables to infer the estimate. After letting that sink in, realize that the concept of the Neutral Rate is one of the building blocks in formulating future monetary policy!

The one thing FOMC members do agree on is that the current level of the Funds rate (4.50% - 4.75%) is above the Neutral Rate, so monetary policy is considered too tight. This is why the consensus believes the Funds rate should be lowered. This widespread agreement among FOMC members is why I think the FOMC will lower the Funds rate by 0.25% at the December 18 meeting. The problem is that no one on the FOMC knows exactly how much the Funds rate needs to come down in 2025 to be at the Neutral Rate, as the Minutes of the November 7 meeting indicated. “Many participants observed that uncertainties concerning the level of the neutral rate of interest complicated the assessment of the degree of restrictiveness of monetary policy and, in their view, made it appropriate to reduce policy restraint gradually.” The best guess for the current level of the Neutral rate is 1.0%, which makes the neutral level for the Funds rate at 3.0%, after adding the FOMC’s 2.0% inflation target. A conservative FOMC member might be concerned that the Neutral Rate was closer to 1.5% than 1.0%. That could imply 3 rate cuts would be appropriate in 2025, rather than the 4 cited in the September SEP. If a majority of FOMC members think the Neutral Rate is close to 1.0%, the Median projection will remain for the Funds rate to fall to 3.4% at the end of 2025. As Chair Powell’s comments during the press conference and the minutes of the last meeting noted, monetary policy is not on a preset course. FOMC members know that the projection they make in the December SEP is ephemeral.

The second factor that will impact monetary policy in 2025 is uncertainty. As we have seen, economic data can be revised significantly and President Trump’s agenda has the potential to increase inflation and either provide the economy a lift or be a depressant. No one knows how other countries will respond to an increase in US tariffs. President Trump’s nominee for Treasury Secretary Scott Bessent framed the coming trade negotiations last June. “We are going to have to have some kind of a grand global economic reordering. I’d like to be a part of it. I’ve studied this.” Bessent is also a fan of using tariffs as a negotiating tool, as he recently wrote to investors in his hedge fund Key Square Capital Management. “President Trump is right that actual free trade is desirable. It might seem counterintuitive from a free market perspective, but President Trump is also right that in order to actually create a freer and more extensive trading system over the long term, we need a more activist approach internationally. The tariff gun will always be loaded and on the table but rarely discharged.” This assumes the countries we bludgeon with tariffs won’t shoot back. Uncertainty is another reason why the FOMC will lower the Funds rate at the December meeting. Cutting in December moves the Funds rate closer to the Neutral Rate, and buys FOMC members time to assess whether Trump’s agenda gets through Congress and whether trade negotiations contribute to inflation. This is why another rate cut at the next meeting on February 1, 2025 is unlikely.

Economy

In the first quarter of 2024 Federal spending fell -0.4%, but rebounded in the second quarter with an increase of 4.3%, and in the third quarter soared 9.7% from the second quarter. One might conclude that the Biden Administration was doing its best to make the economy look great in the run up to the election. Federal spending won’t be increased at that rate in 2025, so the economy will decelerate as this source of growth is reduced.

As discussed in the September Macro Tides the economic bifurcation within the US economy has become more extreme. The 50% appreciation in the Median home price since 2020 has increased the Net Worth of homeowners, as the run up in the stock market has enriched those who have a investment portfolio. Americans who rent an apartment or home and don’t have an investment portfolio haven’t seen an increase in their Net Worth. The increase in the cost of living (inflation) has been a big negative for those struggling to make every pay check stretch. For those with incomes above the Median income of $80,610, inflation was more of a nuisance and fodder for cocktail party chatter. Here’s a list of categories and how much each has increased in the last 4 years. CPI Medical Care: +9.0% CPI Apparel: +12.3% CPI Used Cars: +14.0% CPI New Cars: +19.7% CPI Food at home: +22.3% CPI Shelter: +23.9% CPI Food away from home: +25.0% CPI Electricity: +30.4% CPI Gas Utilities: +32.2% CPI Transportation: +42.6% CPI Gasoline: +44.8% US Home Prices: +45.1% CPI Fuel Oil: +53.0% CPI Auto Insurance: +63.0%.

After consumers received direct Covid payments from the Federal Government in 2022, lower income families were able to handle the increase in the cost of living as they used Excess Savings to stay afloat. In 2023 and 2024 the Excess Savings pool lower income families relied on were exhausted, which is why they didn’t see the economy as being good. Numerous polls prior to the election showed 65% of voters rated the economy as poor or not so good. On the issue of the economy voters favored President Trump by 69% to 29% for VP Harris. This is probably why Democrat’s plurality in Democrat strongholds was cut in half in 2024 versus the 2020 election New York 11.6%, Illinois 8.2%, Minnesota 4.3%, New Jersey 5%, and New Mexico 5.5%. This explains why President Trump won the popular vote for the first time since the 2004 election (76.9 million to 74.4 million).

While the economy helped President Trump win a second term, it also created expectations that could prove difficult to meet. Voters may expect President Trump to lower the cost of living quickly. Prices would need to decline and not just go up more slowly. The overall cost of living isn’t going to deflate in the next two years, unless there is a recession. There is a risk tariffs on imported goods from our largest trading partners - Mexico, Canada, and China – could inflate the cost of some goods as they did after the 2018 tariffs on China were implemented. The midterm elections in 2026 could see losses for Republicans, if the cost of living hasn’t been reduced for lower income families. The 2017 tax cuts are likely to be pushed through, but there are Republicans who are fiscally conservative that may demand concessions. Their resistance could prevent President Trump from fulfilling campaign promises to exempt tips and overtime income from taxes, no income tax for Social Security distributions, or allowing auto loans interest to be deductible. President Trump has proposed lowering the capital gains tax from 21% to 15% and restoring the full expensing of Research and Development. Fiscal conservatives (an endangered species) may want reductions in spending to pay for the loss of government revenue (tax cuts).

The financial squeeze on lower income families may be starting to move up the income scale. The CEO of WalMart said they took business away from competitors in the third quarter. The CEO said that 75% of the increase in market share was from households with income of more than $100,000. Most people shop WalMart to stretch their monthly budget because they think prices are lower. If upper middle income families are shopping at WalMart, the higher cost of living is leading them to change their behavior. This suggests a wealthier segment of consumers are becoming more selective with their spending.

As the FOMC hiked interest rates from 0.12% in March 2022 to 5.375% in June 2023, banks increased their Lending Standards meaningfully. From experience banks know that such an aggressive increase in the Funds rate by the FOMC has always preceded a recession. By hiking Lending Standards banks hoped to limit credit losses that develop as borrowers default on loans during a recession. The distribution of $2 trillion to consumers and small businesses in response to the Pandemic is one reason why a recession has been avoided. Crisis level spending and budget deficits of more than 6.4% of GDP by the Federal government in 2023 and 2024 provided support as well. Many homeowners refinanced their mortgage with a rate below 4.0%, so as mortgage rates soared they were unaffected. Public corporations fortified their balance sheets by selling bonds when yields were historically low in 2020 and 2021. But bonds mature and will be refinanced at higher yields in 2025 and 2026.

Small businesses rely on banks for credit so they have been burdened by the higher FOMC induced cost of borrowing and the tightening of Lending Standards. Since 2021 the average rate paid by small businesses has doubled from less than 5.0% to more than 10%. In the third quarter banks didn’t increase Lending Standards further, but they didn’t ease them so access to credit is still tight for the majority of small and mid sized businesses.

In 2024 auto loan delinquencies rose at the fastest pace since the Financial crisis, and Credit Card debt that is more than 90 days past due reached 11.1% in the third quarter. In response to this deterioration, the rejection rate for Credit Card, Mortgage, and Auto loans increased sharply in 2024, according to the October Survey of Consumer Expectations by the New York Federal Reserve.

The high cost of borrowing for small and mid sized businesses, tight Lending Standards, increase in the rejection rates for consumer loans, and huge increase in Personal Interest payments are all stress points on the economy. The FOMC will lower the Funds rate gradually in 2025, which will help lower the cost of small business loans and provide modest help in reducing Personal Interest payments. The main thrust of President Trump’s agenda will provide little help in lowering the financial stresses small businesses face and many consumers feel in the first half of 2025.

President Trump’s election as President has increased expectations on Main Street and Wall Street. The Republicans control the White House, Senate, and House, so the expectation is that much of President Trump’s agenda will quickly make it through Congress. Progress will be slower than expected as the Republican plurality in the House and Senate are narrow, and every Republican won’t be on board on every issue. For certain, the Democrats will attempt to impede, slow, and defeat any legislation they don’t like, which likely means everything. Once legislation is passed it will take time to implement and have a material impact on the economy, which could easily be in 2026 and not 2025.

President Trump’s initial focus appears to be on overhauling every trade deal we have with every trading partner. The ‘negotiations’ are likely to be tumultuous at the onset with much back and forth. Eventually, deals will be realized but there will be disruptions. And it would be a surprise if there aren’t break downs as the deals are hammered out. The economy and legislative success in the first half of 2025 isn’t going to match the optimistic expectations that are running rampant in the weeks following the election.

Dollar

On October 17 the cover of ‘The Economist’ magazine showed the Dollar mounted on a rocket with the headline, “The Envy of the World”. On October 17 the Dollar closed at 103.82. It’s interesting that the cover suggests the Dollar has been super strong, but fails to acknowledge that the Dollar was actually down –9.5% from its high of 114.78 on September 26, 2022. By the time an economic trend, equity sector, or a stock makes it to the cover of an important financial magazine, the trend has been in place for a long time. In many cases a cover story indicates that the trend is maturing and nearing an end. In this case the top occurred on September 26, 2022, but it may mean another sharp decline is coming sooner than later. On November 5, and before the results of the election were known, the Dollar closed at 103.42. On November 22 the Dollar traded up to 108.07 for a post election gain of 4.5%. That’s a big move for any currency, but the world thinks the Dollar will benefit from President Trump’s agenda.

Many factors influence the strength or weakness of the Dollar. The level and direction of interest rates play a role, as does the amount of the U.S.’s trade and current account deficits. Trade surpluses have been M.I.A. for a long time, but that hasn’t precluded significant Dollar rallies. The economic outlook for the U.S. economy is also a factor. However, even though the U.S. economy was in recession in 1981, 1982, and in 2009, the Dollar rallied smartly. While each of these factors influences the direction of the Dollar, I have found that the level and direction of interest rates, trade and current account surpluses or deficits, or the health of the U.S. economy are not consistently accurate in identifying the trend of the Dollar. They work for awhile, and then they don’t.

Over the last 40 years, one factor has consistently exerted more influence over the Dollar’s trend than any other. The global perception of the sitting President and his Administration’s perceived support of a strong or a weak Dollar has been more consistent than any of the other fundamental influences. President Reagan was perceived as a strong leader around the world. After Reagan was elected President in November 1980, the Dollar rocketed from 95.0 to 164.0 in February 1985. This increase of more than 70% occurred despite the fact that the Federal Funds rate fell from 20% in 1981 to under 8% in 1985. The trade deficit, after being in balance in 1981 when Reagan took office, swelled to 3% of GDP in 1985. When the U.S. agreed to devalue the Dollar in September 1985 (Plaza Accord), the Dollar subsequently fell below 90 in 1987. The decline in the Dollar occurred even though the U.S. economy continued to grow strongly after 1985. When Treasury Secretary Robert Rubin said “We believe in a strong Dollar” in the 1990’s during the Clinton administration, the Dollar strengthened from 81.0 to 106.5 in October 2000 (+31.5%). During that period of appreciation, the economy was strong, but the Federal Funds rate was basically flat, so the influence from interest rates was negligible.

On February 16, 2001, Treasury Secretary Paul O’Neill spoke in Palermo Sicily at his first International Economic Conference. “We are not pursuing, as often said, a policy of a strong Dollar. In my opinion a strong Dollar is the result of a strong economy.” His differentiation from Robert Rubin’s steadfast support of a strong dollar was apparent to currency traders. BNP Paribas thought O’Neill’s comment represented a fundamental shift in policy, while Rabobank International wrote that the currency market would interpret the comment as the U.S. wanting a weaker Dollar. After leaving office in February 2003, O’Neill said, “I was not supposed to say anything but ‘strong Dollar, strong Doctor’. I argued then and would argue now that the idea of a strong Dollar policy is a vacuous notion.” The Dollar held up until July 2001, when it topped at 121.02 and posted a secondary high of 120.02 in early 2002, primarily due to weakness in the Euro which represents 57.6% of the Dollar index. Between May 2002 and May 2003, the Dollar lost a -21% against the Euro and -9% versus the Yen. On May 18, 2003 the Dollar’s descent was given a further shove by Treasury Secretary Paul Snow, (who succeeded O’Neill in February 2003). Snow described the Dollar’s fall against other major currencies in the prior year as a “modest” realignment. For currency traders this amounted to a green light to sell the Dollar and they did. Between July 2001 and March 2008 the Dollar declined -42%, falling from 121.0 to 70.0. (Dollar chart pg. 13)

During the Obama administration the Dollar was treated with benign neglect as comments by Treasury Secretary Geithner and Jack Lew were supportive but infrequent. In November 2009 Geithner said it was important to maintain a strong Dollar. In October 2010 he offered a somewhat backhanded support for the Dollar. “It is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity. It’s not a viable, feasible strategy.” The most notable currency action by Treasury Secretary Jack Lew was the decision to replace Andrew Jackson on the $20 bill with abolitionist Harriet Tubman by 2020. “With this decision, our currency will now tell more of our story and reflect the contributions of women as well as men to our great democracy.”

I recount this history since President elect Trump has expressed his support of tariffs as a negotiation tool aiding his goal of bringing jobs lost to trade back to America. In a May 2016 interview on CNBC, candidate Trump provided his view of the Dollar. “I love the concept of a strong Dollar, and in many respects obviously I like a strong Dollar. While there are certain benefits, it sounds better to have a strong Dollar than in actuality it is.” I don’t think President Trump has changed his view since 2016. This statement provides a valuable insight as to how President Trump might respond if the Dollar increases in value in 2025. It suggests that President Trump might not hesitate to weaken the Dollar, if he thinks it will help future trade negotiations, improve U.S. trade competitiveness, and bring jobs back to the U.S.

When the U.S. wanted the Dollar to fall in 1985 it enlisted the help of our major trading partners to say they would intervene if necessary to bring it down. The currency market is so much larger today than in 1985 that an Administration only needs to convince foreign currency traders which way it wants its currency to trend. In March 2014 Mario Draghi (President of the European Central Bank) discussed why the strength in the Euro was becoming counterproductive. “The strengthening of the Euro exchange rate over the past eighteen months has certainly had a significant impact on our low rate of inflation and is therefore becoming increasingly relevant in our assessment of price stability.” In my April 2014 Macro Tides, I discussed what the ECB might do to cause the Euro to decline. “All the ECB may need is for Draghi to state the desire for a lower Euro. Currency traders would be happy to accommodate the ECB’s wishes, since they could sell the Euro short knowing they were doing so with the blessing of the ECB.” I expected the Euro to decline. After the ECB’s meeting on May 8, 2014, Mario Draghi said, “The strengthening of the exchange rate in the context of low inflation is a cause for serious concern.” It didn’t take currency traders long to figure out what Mario Draghi wanted. The Euro declined from 138.00 in April 2014 to under 105.00 in April 2015, a decline of -25.0%. Currency traders are nihilistic and would embrace shorting the Dollar and the profits it would generate, if President Trump discussed the benefits of a weaker Dollar. Sometime in 2025, I expect Trump to convey to currency traders (via a tweet?) that the Dollar is too strong and that he will tolerate a weaker Dollar.

From a high of 114.74 in September 2022, the Dollar declined 15.21 points to 99.59 in July 2023. Since the low of 99.59 the Dollar has been retracing a portion of that decline, which took the form of a rally to 107.34 (A green), pullback to 100.16 (B green), and the recent rally to 108.07 (C green). A 61.8% retracement of the 15.21 point decline was 108.99, so the high of 108.07 is close. With this A, B, C retracement, the counter trend rally from 99.59 appears complete, setting the stage for another large decline. If the next drop is equal to the first decline of 15.21 points, the Dollar will fall to 92.86 (108.07 – 15.21 = 92.86). The first decline lasted from September 26, 2022 to July 10, 2023 or 41 weeks. If the coming drop is equal in time a low would develop in August or early September 2025. A close above 109.75 would challenge this outlook.

Treasury Yields

The consensus is for Treasury yields to move higher since the Trump agenda is forecast to keep the economy humming and his tariffs policy will cause inflation to increase. This combination is expected to lead the FOMC to make fewer cuts in the Funds rate in 2025. If President Trump is able extend the 2017 tax cuts and other promised tax cuts, the bond market could become overwhelmed with the perception or actual flood of Treasury debt issuance. These are all legitimate and possible concerns. Just because Treasury yields have increased since mid September doesn’t mean yields can’t go higher, if these worries are realized in 2025. There are though signs that these concerns may be overblown, and some nascent signs that Treasury yields have peaked.

In the last few years the correlation between the Dollar and the trend in the 10-year Treasury yield has been pretty tight. At times it almost looks like Dollar strength has pulled Treasury yields higher. The largest declines in the 10-year Treasury yield were accompanied by sharp drops in the Dollar. If the pattern analysis for the Dollar is correct, and the Dollar is on the cusp of a large decline during the next 10 months, Treasury yields can be expected to trend lower.

Treasury yields bottomed on September 18 when the FOMC lowered the Funds rate by 0.50%. The march higher was aided by economic data that exceeded estimates, which is why the Economic Surprise Index (ESI) moved up strongly. As the ECI increased in response to better data from January 2024 into April, the 10-year Yield rose from 3.81% in January to 4.73% in April. After peaking in October 2023 and April 2024, Treasury yields dropped significantly as the ESI trended lower.

The ESI recorded a high recently and has begun to fall as some economic data came in below estimates. Obviously, more disappointing data will be needed in coming weeks and months to create a deeper down trend in the ESI. In the short term the ESI may hold up for awhile as it did from mid February to mid April. If it does Treasury yields may chop sideways. Remember the ESI is determined by positive and negative surprises relative to economist’s estimates. The election has increased expectations for growth in 2025, so estimates have increased, which will make it easier for actual data to come in weaker and cause the ESI to decline. The table is set. Now we have to wait until dinner is served.

In the press conference on November 7 Chair Powell was asked about the 5-year inflation breakeven rate. His answer was informative. “We would be concerned if we saw longer term inflation expectations anchoring at a higher level. That's not what we're seeing. Expectations seem to be consistent with two percent inflation. But you're right to say we watch that very carefully.” As the 10-year Treasury yield was approaching 5.0% in October 2023, the 5-year Breakeven Rate topped at 2.52% on October 19. After 3 consecutive bad inflation reports in the first quarter of 2024 showing that inflation was rising, the 10-year Treasury yield ticked up to 4.73% on April 25. The 5-year Breakeven Rate had already topped at 2.52% on April 16.

The consensus among economists is that President Trump’s tariffs will cause inflation to increase. The only question is by how much. While these concerns are being aired nonstop, the 5-year Breakeven Rate topped at 2.46% on November 6 the day after the election. On November 27 the 5-year Breakeven Rate was 2.32%. The Breakeven rate hasn’t moved above the prior highs of 2.52% after the election even with all the prognostications for higher inflation. That’s supportive of lower Treasury yields, as long as the 5-year Breakeven Rate continues to fall and doesn’t close above 2.52%.

As I noted in the November 18 Weekly Technical Review (WTR), “Sentiment toward Treasury bonds is extremely negative so a trading low is approaching.” The low in TLT occurred on November 18. I discussed the short and long term pattern in TLT in the November 25 WTR.”TLT is expected to close above 93.10 opening the door for a rally to 94 – 96. It gets tricky if TLT rallies to 94 – 96, since a decline to near or below 87 is still possible. TLT closed above 93.10 on November 29.

I still think a rally above 101.64 is more likely since the economy isn’t as strong as thought and the economic benefits of the Trump agenda won’t impact the economy until late 2025 or in 2026. A rally above 101.64 would represent Wave C (green) off the October 2023 low of 82.42, and it would unfold as 5 waves. Wave 1 could lift TLT to 94 – 96 and be followed by a Wave 2 pullback. Wave 3 can be expected to develop as the economy shows real signs of slowing.

Although the following outcome is less likely than a rally above 101.674, from a risk management perspective it must be respected as the higher rate scenario can’t be dismissed. After falling from 179.70 in March 2020 to 82.42 in October 2023, TLT rallied to 101.64 in 3 waves. This 3 wave rally may be all of the counter trend retracement of the decline from 179.70 to 82.42. If correct, the decline from 101.64 to 89.421 is wave 1 of a 5 wave decline that would take TLT well below 82.42. In this case a rally to 94 – 96 or a bit higher would represent wave 2, before another large decline takes hold.

The initial 33% long position was taken on September 26 when TLT at 97.64 and the second 33% position was established at 95.40. The final 33% position was established when TLT opened at 91.84 on October 23. The average price of the position is 94.96. My inclination is sell some or all of this position if / when TLT trades up to 95.00 or higher. We’ll take it one week at a time.

Stocks

Psychology and sentiment play a much bigger role in the stock market than most investors realize, since the major focus is on the economy, monetary policy, and the trend in corporate earnings. Psychology and sentiment spend most of the time around a mid point, so it’s not on investor’s radar. Psychology and sentiment provide the best information after swinging to an extreme. The market approaches a long term bottom only after undergoing a large decline in response to bad economic news (recession) or a crisis (Financial, Geopolitical). In response to negative news investors sell. A long term top forms after an extended period of good economic news and great returns that pulls investors into the market in anticipation of higher prices. The level of risk changes as psychology and sentiment swing from the extremes of fear and greed, but most investors are swept up by the subjectivity of emotion. This is why the majority of investors are more invested at tops and hardly invested at bottoms.

This quote from Daniel Crosby’s book ‘The Behavioral Investor’ sums the inversion of psychology at tops and bottoms well. “Our flawed brain leads us to subjectively experience low levels of risk when risk is actually quite high. While we tend to think of bear markets as risky, true risk actually builds up during periods of prosperity and simply materializes during bear markets. During good times, investors bid up risk assets, becoming less discerning and more willing to pay any price necessary to take the ride. Risks compound during such periods of bullishness, but this escalation goes largely undetected because everyone is making money and the dopamine is flowing. You likely grasp this intellectually, but your brain will do everything in its power to make sure that you don’t act accordingly.”

Joe Granville published the Granville Market Letter and is one of the people that got me into learning technical analysis a long time ago. Joe was one of the first technical analysts to focus on the 200 day average for the DJIA, and invented On Balance Volume, which is a staple in technical analysis charting programs. He said, “I observed that when people are entertained, they will retain more information.” While providing technical analysis insights Joe Granville entertained. He gave talks on the stock market while dressed in outfits that Elvis Presley might envy. Once he made an entrance "walking on water" across a swimming pool. In his letter, he would refer to bank trust officers who controlled private wealth as "monkeys" and often trotted real monkeys out on stage, dressed in three-piece, pin-striped suits to mimic the Wall Street gang. He once filled Carnegie Hall and gave the audience financial advice, then played his theme song, "The Bagholder Blues" on the piano. In Joe’s parlance a Bagholder was an investor who was fully invested as the stock market formed a top.

Investors are quite bullish and who can blame them. The economy is good, the FOMC is lowering the Funds rate, the stock market is trending higher, and President Trump has plans to make everything better. This is an accurate description, and our brains are telling us that this is a great time to be invested. But things change. At some point the economy is going to slow and possibly experience a recession. President Trump’s agenda won’t sail through Congress and trade negotiations will be with other politicians, who will want and need to show the voters in their country that they got concessions from President Trump that will make those voters vote for them again. There will be bumps in the tariff road.

However, in the near term the Honeymoon will persist and the positive seasonal effect going into year end is supportive. As noted in the November 25 Weekly Technical Review, “The S&P 500 will likely trade above 6100 despite the weakness in the Mega cap stocks.”

The economy is expected to flourish under President Trump, which is why cyclical sectors and the Russell 2000 are being bought, as Nvidia, Semiconductor stocks, and other Mega cap stocks are sold. As the S&P 500 recorded a new high on November 29, the Semiconductor Index (SMH) traded -14.4% below the high it reached in July. SMH has the potential to bounce to 256 – 262 near term, which would help the S&P 500 trade above 6100. The negative divergence between the S&P 500 and the Semiconductor Index is not a positive, but in the short term won’t matter as long as money continues to flow into cyclical sectors and the Russell 2000.

The rotation into cyclical stocks has lifted the Advance – Decline Line to a new high. The margin is small only 883 issues, but the Negative Divergence has been eliminated. Ideally, the A-D Line will hold above the recent low during the next correction.

The Russell 2000 finally exceeded the top it recorded in November 2021 (2459) almost exactly 3 years ago when it traded up to 2466 on November 25. The breakout at 2300 was retested for four days successfully in mid November, so the intermediate trend is up unless the Russell 2000 closes below 2300. After testing resistance near 2280, the Russell 2000 repeatedly found support between 2000 – 2100. A rally of 180 to 280 points above the resistance of 2280 suggests a top between 2460 and 2560.

Traders have aggressively jumped on the rally in the Russell 2000. The chart shows positioning in the Russell 2000 through the use of futures and leveraged ETFs, and is at the highest level in 15 years. The rally has already pulled in a lot of money, which is why a top in the Russell 2000 will signal at least a short term high in the S&P 500. Cyclical stocks and the Russell 2000 will become vulnerable to a large decline if / when the economy shows definitive signs of slowing next year.

Gold

As noted in the November 18 Weekly Technical Review, the current correction in Gold is Wave 4 from the low of $1608 in September 2022 and should last about as long as Wave 2 did. “The current correction is Wave 4 and should approximate the time Wave 2 consumed which was more than 4 months.” This suggests the correction could last until February.

Gold was expected to rally after its sharp decline from $2789 to $2541. “Gold is expected to retrace a portion of the $248 decline from $2789 to $2541, before another decline completes Wave 4. If Gold retraces 61.8% of the $248 drop, it would rally to $2694 in an a-b-c move.” Gold jumped to $2719 in overnight trading on November 25 and then plunged to $2618 after a possible cease fire by Israel and Hezbollah was announced. This news inspired sell off suggests Gold will rebound and could rally above $2719 to complete the a-b-c rally for wave b. Sooner or later, Gold is forecast to drop below $2541 in wave c before Wave 4 is complete. Once the Wave 4 correction is over, Gold is expected to rally to a new high above $2789.

The Daily Shot

Every month I include dozens of charts and the majority of them come from The Daily Shot. I highly recommend those who like charts of economic data to subscribe to The Daily Shot, https://thedailyshot.com

Jim Welsh

@JimWelshMacro
[email protected], MacroTides.com

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