Wait Till Next Year
Three policy shocks have reduced demand for labor and slowed growth, trade war update, the end of QT, very few cockroaches in banks, 10s below 4%
Note: We are traveling this weekend and again early Monday morning, our video summaries may be delayed until Monday afternoon when we arrive in Chicago to speak at Institutional Investors 2025 Fixed Income Trading Summit.
In this week’s note:
Growth slowed in response to three policy shocks, but the mix is more favorable for investors, particularly fixed income investors.
The trade war heated up this week, China is overplaying their hand.
Chair Powell effectively announced the end of QT; we do a deep dive on the balance sheet and outlook for the duration of the SOMA portfolio.
A couple of large credit defaults and Jaime Dimon’s cockroach comment sparked a selloff in banks; the concerns are unfounded.
Earnings revision momentum appears to be peaking in the AI related sectors ahead of earnings season.
With 10s breaking below 4% we remain cyclical bulls, but secular bears on Treasuries.
Just Wait till Next Year
“Economic activity changed little on balance since the previous report, with three Districts reporting slight to modest growth in activity, five reporting no change, and four noting a slight softening.” The Beige Book, October 2025
In the early days of the Trump Administration, on February 22, we wrote Cleaning Up the Industrial Policy Mess, a process Treasury Secretary Bessent labeled detoxing from the country’s addiction to government spending. Spending slowed from 11% in fiscal year ‘24 to 3% in FY25, and the effective tariff rate increased from 2.5% to 12% from February through August. One of the most important lessons of the pandemic was the underlying dynamism and resiliency of the private sector US economy. In the first 9 months of the Trump Administration, in addition to the government spending and tariff shocks, the private sector has absorbed the largest swing in population growth in US history. The shocks left a mark; the year-to-date S&P 500 sector returns illustrate the effects. The beneficiaries of the AI boom are leading the way, the communication services sector is +23.5%, utilities are +22.5% and the tech sector is +21.6% (through Wednesday). Investment and deregulatory beneficiaries’ industrials and financials are +15.7% and 10.0%. Consumer sectors are struggling with the impact of slower government spending and tariffs, staples are +3.4% and discretionary +2.6%. The healthcare sector is struggling with policy changes as well and is lagging the S&P 500 badly +2.9%.
Stronger investment, slower consumption and a smaller government contribution to growth are a favorable mix for equity and fixed income investors, and the 13.4% S&P 500 price return and 54bp drop in the yield-to-maturity of the 10-year Treasury reflect optimism about a more optimal mix of growth. The key word is optimal, robust nominal growth in ‘23 and ‘24, driven by personal and government consumption, with weak investment, was a decent environment for equities, but negative for Treasuries due to the inflationary impulse from government spending. Nonetheless, even in the absence of government data, it is increasingly apparent, as evidenced by the October Beige Book, that the immigration, government spending and tariff policy changes, as well as the ongoing drag from the Fed’s unbalanced policy tightening, has reduced demand for labor and slowed growth. For investors accustomed to integrating the rate of change into their analysis it is tempting to conclude the impact of these policy changes will fade in ‘26. To be sure, the associated uncertainty negative impact on capital and labor investment will dissipate, however the negative effects of slower population growth, higher tariffs and reduced government spending on output (GDP, GDI) and employment will persist.