- Fixed Income Portfolio Manager
United States, Institutional
Change
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A slack tide is the brief period in a body of tidal water when the water is completely unstressed, and there is no movement either way in the tidal stream. It occurs before the direction of the tidal stream reverses.
We tend to view fixed income markets as a constantly evolving, probability-weighted, expected-value equation. Simply put, this means seeing a good result (outcome A) and a bad result (outcome B). I believe trying to predict the right future outcome and position your portfolio accordingly is futile. I find more value in identifying a crowded trade — where the probability of outcome A is perceived to be much higher than the probability of outcome B — and analyzing why outcome B may be more likely than market consensus and pricing imply.
Today, I believe the market is pricing the likelihood that the Trump administration’s policies will support US growth and lengthen the economic/credit cycles as outcome A. Outcome B — in which Trump’s policies negatively shock growth and tighten financial conditions in the US — may be more probable than the market expects. Why? Let’s look at the following:
- Spending cuts: The Trump administration's focus on cutting spending and waste, while potentially beneficial long term, could significantly hinder short-term growth. Since the beginning of COVID-19 in early 2020, federal outlays (expenditures) have represented an average of 25% of US GDP, up from an annual average of 19% for the prior six decades.1 In my view, you simply cannot cut off the flow of hundreds of billions of dollars of federal money and expect the US economic engine to keep humming the way it has been.
- Tariffs: With so many moving parts, tariffs are complex to model, but my gut says they are more likely to be a headwind to growth than a meaningful catalyst for inflation. While it may turn out that Mr. Trump is using them as a negotiating tool, I see them as the only significant “source of funds” in his economic plan. In other words, the administration may need tariffs to fund tax-cut extensions and further stimulus. What this misses, of course, is how disruptive this posturing is for global trade and how much it introduces uncertainty, to which the US is not immune. Growth outside the US is lackluster at best.
- Fourth-quarter growth: The strength of the US economy in the fourth quarter of 2024 may have been due to rapid cash disbursement by the outgoing Biden administration and anticipatory spending by consumers and businesses ahead of tariffs. This could mean growth was pulled forward, potentially at the expense of future growth.
- Immigration: Immigration has not only been a positive catalyst for labor supply growth, but also a stimulant for aggregate demand. The effect of slowing immigration and large-scale deportations on inflation is a tougher call, but I believe it is likely growth negative. With fewer people seeking housing, food, goods, and services, will prices adjust downward? The effects could be especially acute in the housing sector, as the US has been aiming to close a structural housing-supply deficit.
- Employment: The Trump administration's buyout offers for federal employees, which aim to reduce head count, could hamper job creation. A striking 46% of US jobs added since January 2022 have come from the government and education/health services sectors.2 Reduced hiring or job losses in these areas could significantly impact top-line job creation.
- Yield curve: The inversion of the US yield curve could serve as a true recession signal, unlike in 2022 and 2023, when it proved to be a false alarm. This time, we could see a scenario where the curve inverts because the Federal Reserve (Fed) remains hawkish on inflation while market participants buy long-duration Treasuries, hoping for a more attractive hedge against a growth slowdown. The back end of the curve could also go lower because the market may start to price in better-than-feared deficits, as much recent yield-curve steepening may be a product of concerns around deficits. In my view, an inverted yield curve would be a troubling signal for credit markets, and we could see spreads widening from their current, very tight levels.
Overall, I see the Trump administration's actions since taking office as growth negative. The stimulus measures it wants require Congressional approval and are not guaranteed. Today’s federal deficit and the fiscal stimulus pushed into the economy since the pandemic are unprecedented, with current spending relative to GDP historically seen only during crises, when growth was cratering.
I sense that the administration understands that the bond market may govern the amount of stimulus it can add. Further fiscal profligacy will likely come at a cost, through the level of bond yields. Contrary to the market’s reactions during the past five years of rising fiscal deficits, we may have reached the upper limit of how much fiscal stimulus the government can provide.
If that’s correct, then the only direction for stimulus to go from here is down. And if the government starts cutting spending, I believe the likelihood of a US recession goes way up and could lead to the reduction of US Treasury issuance.
We may be at the slack tide point for US fiscal stimulus, meaning there will be a brief period of apparent calm before the flow reverses.
1US Treasury Department, 1954 to 2024. As of 31 December 2024. | 2Bureau of Labor Statistics. January 2022 to December 2024. As of 31 December 2024.
