Do it yourself: April 2025

Wednesday, April 30, 2025

Straitjacketing a crisis-2

Continuing from yesterday…(see here)

As I mentioned that the old narratives of the Smoot-Hawley Tariff Act (Tariff protection for domestic businesses), New Deal (Fiscal profligacy to stimulate economy) and Plaza Accord (fiscal and monetary manipulation by government/central banks to balance trade) do not fit the current circumstances, given the vastly different context. The efforts to fit the current U.S. President’s economic actions (and promises) related to trade, tariffs, and fiscal policy into historical molds, don’t align with today’s reality, and may be an exercise in futility.

For example, consider the following:

· In 1930, global trade was 5% of U.S. GDP, and the world economy was already in freefall post-1929 crash. In 2025, trade is a larger share of GDP (e.g., ~25% for the U.S.), but global supply chains are far more integrated, making outright trade wars costlier and less likely. Modern trade agreements (e.g., USMCA, WTO) and digital economies add complexities that were not present in 1930.

Smoot-Hawley’s tariffs were sweeping and indiscriminate (40–60% increase across the board). Current U.S. tariff proposals (e.g., 10–30% on imports, higher on China) are targeted; negotiable; and used more as leverage rather than permanent barriers. Retaliation risks exist (e.g., EU or China tariffs), but multilateral frameworks mitigate escalation.

The 1930s lacked modern central bank tools like QE or quicker rate adjustments. In 2025, central banks globally can counteract trade shocks swiftly; unlike the gold-standard-constrained 1930s.

Critics overstate Smoot-Hawley’s relevance, projecting a worst-case scenario without acknowledging 2025’s resilience (e.g., diversified U.S. economy and tech dominance). The analogy ignores that tariffs today are often diplomatic tools, not ideological commitments, unlike Smoot-Hawley’s protectionist zeal.

· The New Deal addressed 25% unemployment and a collapsed banking system. In 2025, U.S. unemployment is low (4–5%), and banks are stable, though inflation and debt ($36T) pose challenges. The urgency for New Deal-scale intervention is absent.

The New Deal was a comprehensive overhaul of the extant system. Adherence to Keynesian theory was at core of the New Deal. Trump’s infrastructure spending may echo WPA projects, but without the New Deal’s social safety net expansion or unified vision. Besides, current policies are often stalled by partisan gridlock or judicial review, unlike Roosevelt’s legislative dominance.

The New Deal’s trade liberalization (1934 Act) countered Smoot-Hawley’s damage. In 2025, trade policy is biased towards protectionism, not liberalization; and global allies are skeptical of the US leadership, unlike the 1930s’ pre-WWII alignment.

· In 1985, the G5 shared aligned interests (Cold War unity, Japan’s deference). In 2025, the Sino-US rivalry, EU autonomy, and BRICS expansion (e.g., India’s growing role) complicate cooperation. A coordinated currency intervention (like in Plaza Accord) is unlikely given China’s managed yuan and the US political volatility.

The Plaza Accord used currency markets, not tariffs or fiscal policy. Current US actions emphasize more on tariffs and sanctions, not multilateral agreements, reflecting unilateralism over 1985’s teamwork.

The Accord strengthened the US’s exports but sparked Japan’s asset bubble and a lost decade. In 2025, similar interventions risk unintended consequences (e.g., inflation from a weaker dollar), but global economic fragmentation reduces the Accord’s replicability.

G-5 has now been replaced with G-20, which is not necessarily aligned with the US on trade or geopolitical issues.

· Unlike 1930 or 1985, today digital economies (e.g., AI, e-commerce) and global supply chains dominate trade. A 1930 like trade war would disrupt tech flows (e.g., semiconductors), not just goods, with broader fallout. Similarly, a New Deal’s public works may be much less transformative today when remote work and AI are reshaping labor markets.

· Current US political polarization and debt levels materially constrain a New Deal-scale ambition, while cultural shifts (e.g., distrust in institutions) differ from 1930s’ unity or 1985’s optimism.

In my view, rather than forcing old frameworks in the current crisis, it would be more useful if the US policymakers craft a “new solution” suitable to 2025 conditions. The new solution may, for example, include:

· Fair taxes on trade: Tax goods from some countries but let allies like India sell clothes or spices without extra costs. This keeps prices low for Indian shops and helps American workers.

· Green projects: Build solar panels, electric car batteries and chargers, like new roads in the 1930s, to create jobs and fight climate change.

· Global teamwork: Create a new group with India, China, and others to agree on development of a neutral digital currency for international trade settlements; framework for global digital payments, like a global UPI, as an alternative to SWIFT, so no one country controls everything. These ideas can help the US to grow together with its trade partners, without repeating past mistakes.

These are just a few of the suggestions. A pragmatic approach, rather than adopting whimsical and jingoistic measures to achieve MAGA goals, will lead all down, including the US.

Tuesday, April 29, 2025

Straitjacketing a crisis

Do you recall Jack Braganza from the popular Hindi movie Bobby (1973)? The affable patriarch wore his marriage suit while visiting the house of Raj, his daughter Bobby’s lover, to discuss their marriage proposal. The suit would not fit him after so many years, but that was perhaps all he had in the name of formal attire.

In the movie, this scene created a comic sense. However, in real life it is not uncommon in millions of lower middle-class Indian families. The men use their wedding attire for decades, before they get a new one made, usually for their children’s marriages.

The narratives that are being built around, arguably, a blunderous act of the incumbent president of the United States (POTUS), reminded me of this movie scene. Experts are trying to use an old jacket to fit the current scenario, based on their personal perceptions and linkages. Some people, harshly critical of the POTUS, have tried to fit the 1930 trade war triggered by the Smoot-Hawley Tariff Act in 1930 – that would plunge the world into a crisis. Some POTUS followers are comparing it with the 1933 & 1938 New Deal – that would help rebuilding America. Yet some others are terming this as a fresh version of the Plaza Accord (1985) – that will usher a new era of global cooperation, progress and American dominance.

In my view, 2025 is an extremely different world from 1930, 1938 or 1985. None of these old jackets may fit the current situation. History is definitely not repeating itself. It may be rhyming to the limited extent

1929-30 – Trade war, Smoot-Hawley Tariff Act in 1930

The US government chose to protect the domestic economy from the adverse impacts of economic crisis building in Europe by undertaking protectionist measures. The Smoot-Hawley Tariff Act, was passed in 1930, to raise import duties by ~20% on over 20000 items. The motive was to protect American farmers and businesses from the global competition and boost domestic manufacturing employment.

The Smoot-Hawley Act led to a significant decline in international trade as 25 countries retaliated with higher tariffs. For example, Canada imposed tariffs on 16 U.S. products, covering 30% of U.S. exports to Canada. U.S. imports fell 66% ($4.4B in 1929 to $1.5B in 1933), exports dropped 61% ($5.4B to $2.1B), and global trade declined 66% (1929–1934). U.S. GDP fell from $103.1B (1929) to $55.6B (1933); unemployment rose from 8% (1930) to 25% (1933).

The Smoot-Hawley Act was widely regarded as a policy blunder, which along with the monetary policy blunder of raising rates during a visible slow down, exacerbated deflationary pressures, leading the world into one of the worst economic depressions ever witnessed.

Another fallout of this tariff was that Senator Smoot and Congressman Hawley (authors of the Act) lost their respective seats in 1932; Republicans faced a historic Senate swing. The Reciprocal Trade Agreements Act (1934) shifted tariff authority to the president, reducing protectionism. Incidentally the incumbent POTUS has used the same authority to start the latest tariff war.

1933-1939 - New Deal, Keynesian government

After a resounding victory in 1932 elections, President Franklin D. Roosevelt offered a deal that would provide immediate relief to the people, especially unemployed and poor and stimulate economic growth through public spending and industrial/agricultural reforms. The deal comprised the five main elements-

1. Civilian Conservation Corps (CCC) and Federal Emergency Relief Administration (FERA) provided jobs and direct aid.

2. National Industrial Recovery Act (NIRA) and Agricultural Adjustment Act (AAA) regulated production and prices to stabilize industries and farms.

3. Glass-Steagall Act (banking regulation), Securities Act (stock market oversight), and Social Security Act (pensions/unemployment insurance) to reform financial and capital markets.

4. Public Works Administration (PWA) and Works Progress Administration (WPA) funded roads, dams, and schools, employing millions.

5. Dilution of Smoot-Hawley tariffs, to empower the president to negotiate bilateral trade deals, boosting exports.

The reforms initiated under the New Deal reduced unemployment from 25% (1933) to 14% (1937), though full recovery awaited World War II. GDP grew steadily (e.g., 10.8% in 1934). Public works created lasting infrastructure (e.g., Hoover Dam). However, the increased reliance on deficit spending and regulation sparked intense debates about government overreach. Besides, some programs (e.g., NIRA) were struck down as unconstitutional, and recovery was uneven. Some critics argued that the New Deal prolonged the Depression by distorting markets.

1985 – Plaza Accord, trade corrections, sanctifying active market management

On 22nd September of 1985, the representatives from the now defunct G-5 met at Plaza Hotel, New York to discuss one of the most remarkable currency manipulation plans. On that afternoon, the US, France, Germany, UK, and Japan signed the Plaza Accord to weaken the US dollar to help the US reduce its burgeoning trade deficit.

As part of the accord, the US agreed to cut its fiscal deficit materially; while Germany and Japan consented to boost their domestic demand by cutting taxes. All parties agreed to actively “manage” their currency markets to “correct” their current account imbalances.

In backdrop to the Plaza Accord, the US Dollar had appreciated about 48% during 1980-1985, primarily induced by the sharp hikes in the policy rates by the US Federal Reserve, led by the Paul Volcker; pressurizing the US manufacturing by making (i) imports from Japan and Germany more competitive and (ii) exports to other countries less competitive. This was the time when US manufacturing giants like IBM and Caterpillar were facing severe stress and lobbying the US Congress for relief.

The US Dollar (USD) depreciated 40-50% against Japanese Yen (JPY) and German Mark (DEM) in the two years following the Plaza Accord. The plan worked with limited success but not without material collateral damage. The US-Japan trade sustained as Japanese automobile and electronic products continued to overwhelm the US consumers. US-Germany trade imbalance corrected materially. A stronger JPY, in addition to the monetary policy blunders of the Bank of Japan (BoJ), however resulted in severe deflationary conditions in the Japanese economy, resulting in the famous “lost decade”.

The Black Monday (19th October 1987) crash of the stock markets over exposed several faults lines in the Plaza Accord.

Conclusion:

Smoot-Hawley was protectionist, prioritizing domestic interests at global expense, and failed miserably pushing the global economy into a deep abyss. The New Deal blended interventionism with trade liberalization. It had limited economic success but introduced several structural anomalies, like wider and deeper regulatory overreach. The Plaza Accord sanctified active market intervention by the government and monetary authorities. It had some short-term success, but long-term impacts have been mostly negative, especially on the German and Japanese economies.

In my view, the current global landscape is fundamentally different from the 1930, 1938 and 1985. Comparing the latest tariff war to push the Make America Great Again (MAGA) campaign to any of the historical precedents would be a futile oversimplification.

…to continue tomorrow

Thursday, April 24, 2025

Rewriting History, Unsettling Society: India’s Cultural Clash and Economic Risks

Not long ago, history used to be mostly an academic subject. The educated elite wrote, studied, analyzed, discussed, debated, formed, and altered history as per the available scientific evidence, their perceptions and affiliations. Their perceptions were perhaps deeply influenced by the political narrative and economic concerns of the times.

The common people were however mostly concerned with their cultural traditions. These traditions passed through generations, have been generally regarded as history. Popular literature and other art forms, e.g. films, theater, drama, paintings, etc. also had significant influence on the common peoples' perception about history.

For common people, the valor of Rajput Kings like Prithviraj Chauhan, Maharana Pratap etc., and sacrifice of queen Padmavati are established through ballads written by poets like Chand Bardai (Prithviraj Raso) and Malik Muhammad Jayasi (Padmavat). Disregarding what academic historians had to say about these legends, people idolized them and passed their stories to younger generations with pride and devotion.

The 1960 Hindi Movie Mughal-e-Azam is an indelible impression of Mughal history in common peoples' imagination in India. Anarkali, which historians vehemently claim to be a totally fictional character, lives in peoples' memory as a historical symbol of love and sacrifice.

Conventionally, the history as taught or studied in schools and universities had little meaning for common people. The knowledge of historians that was based on scientific studies, archaeological evidence, authenticated written accounts, etc., and beliefs of common people based on folklores and oral traditions have stayed within their respective boundaries, without any major conflict. The governments mostly remained neutral, equally supporting both the academic & scientific pursuit of history, and promotion of traditional beliefs.

However, in the past couple of decades, a gradual change in this paradigm is conspicuous. An intense struggle is taking place between the historians and the cultural traditions as practiced by the common people in the country.

There is a concerted political endeavor to overwrite academic history books with traditional and cultural beliefs. The argument is that these history books are deeply influenced and/or distorted by the imperialist British academia who had interest in destroying rich Indian legacy; and in the post-independence era by left leaning elite who find traditional cultural beliefs regressive and unfounded.

Besides, the cultural traditions have also shown a tendency of loosening roots with rising urbanization, labor migration and dissipation of cultural ambience (rivers, animals, trees, temple, priest, forest, time, faith, folklores, oral tradition, family, austerity, etc.). The younger people who are not rooted properly in their cultural traditions are commonly seen adhering to frivolities, ignoring the core ideas deliberately (for practical reasons) or ignorantly (for the lack of proper guidance and inheritance of culture).

This dissipation of traditional Indian cultures is allowing the politicians to influence people into believing that alteration of history books would restore their dissipating traditional cultures and thus reinforce their loosening roots.

I do not know if this is the right approach. Maybe it is. Or maybe it is not. Only time could tell this. I am also slightly skeptical about giving this political endeavor the garb of nationalism and patriotism.

But what I am sure about is that the process is introducing some serious discrepancies in Indian society. The generally affable and compassionate populace appears becoming conspicuously condescending. The friction in the society is rising as the grease of traditional beliefs (tolerance, hospitality, acceptance) dries up.

My travels across the country in the past three decades have told me that India is changing fast, but not necessarily in the direction many of us would desire. Not focusing on the direction of change could nullify the impact of the change itself.

I do not want to engage in any political debate. I also do not wish to sermonize anyone or judge any party or organization by their recent activities, iterations, and ideologies, or lack of it for that matter. As such, I would like to limit myself to my economic interests and in my view, the rising insolence and cynicism in the society is not good news for the economy.

Consequently—

· Suspicious of future policy direction; unconvinced of government promises, and uncertain about the stability of current policy regime - people are reluctant in their investment and discretionary consumption decisions.

· Confidence in the broader India growth story, juxtaposed with skepticism raised by unpredictability & instability of policy and general social distress, is creating a certain degree of cognitive dissonance impacting the decision making as well as disposition of businesses.

· The economy faces a potential threat of getting pushed into a vicious cycle of lower growth-lower employment-lower income-lower consumption-lower investment-lower growth, if immediate steps are not taken to improve business and consumer confidence.

In my view, the government should leave the history vs mythology vs traditional beliefs & customs debate to the people and academics, and focus on strengthening the core of the economy. Let schools teach what academics believe to be correct history; and let parents introduce their children to the culture, traditions and legacy beliefs. This arrangement has worked for over 200 years. The generations that have grown up under this arrangement are no less intelligent or committed to their roots. There is nothing to suggest that the future generations will get uprooted if this arrangement is continued.

Wednesday, April 23, 2025

Priests are feasting

The first three weeks of the FY26 have been rather dramatic for the stock markets. By the end of FY25, the benchmark Nifty 50 was down ~10% from its previous high level recorded in September 2024. Foreign investors were selling persistently. News flow from any quarter was not particularly encouraging. Investors’ sentiment was sagging. Market volumes had plunged over 30% from their 2024 highs. The rate of SIP discontinuation had increased materially, with March 2025 recording net negative addition to operative SIPs. Social media timelines of active market participants were filled with despondency.

FY26 started with the declaration of trade war by the US. Markets that were already reeling under pressure plunged further, with the benchmark Nifty 50 falling another 9% in the first five trading sessions of FY26. Anecdotal evidence suggests that many traders and small investors capitulated and liquidated their positions. Several others churned their portfolios to move to defensive sectors like FMCG, Pharma etc.

In a dramatic turnaround, Nifty 50 has gained over 9% from the lows of 7^th April 2025, erasing all the losses YTD2025. This is perhaps the most hated market rally since 2009. The participation has been poor. In fact, several investors/traders have used the rally to raise more cash.

In my view, the market continues to be in the process of forming a strong bottom and beginning a strong rally. It is early to conclude that a firm bottom is in place and a sustainable market rally is imminent. Nonetheless, the recent market behavior provides significant evidence to conclude that (i) fall from September 2024 was beginning of a bear market cycle (see here); (ii) bottoming process has accelerated with the April first week sharp correction; and (iii) contours of the new bull market have already started to take shape.

In particular, I would like to highlight the following trends to in support of my conclusion:

· A clear leadership appears emerging, with private banks (+13% vs Nifty 50 +3% YTD2025) clearly leading the up move.

· The up move is led by large cap stocks. Small cap (-9% YTD2025) and Midcap (-5% YTD2025) lagging behind in a typical early cycle trend.

· Besides size wise category, sector wise - IT Services (21% YTD2025), Realty (-17% YTD2025), Pharma (-9% YTD2025), Auto (-4% YTD2025) – laggards are also prominent; usually a sign of market cycle transition.

· A sizable number of market participants are still not confident about the sustainability of market rally; implying fear still dominates greed.

· Implied volatility has remained low to moderate, except for a brief surge earlier this month.

· Stock prices of capital market related businesses have recovered fast, indicating that the market participants are confident about the prospects of market activity levels picking up in the short to medium term.

I would also like to take this opportunity to mention the following ancient Hindu tradition, which I find most relevant to the investment strategy of household investors.

Hindu religious traditions mandate that a grand feast must be organized by all Hindus within 3 weeks of the death of their parents, spouse or children. In this grand feast Priests, Dogs, Crows and the poor are served with delicious food. Priests and the poor are also given clothes, gold, cash and other gifts.

Also, as per the ancient Hindu traditions, all Hindus are obligated to serve priests and feed crows during waning moon fortnight (Krishna Paksha) of lunar month of Bhadrapada. It is widely believed that serving priests and feeding crows in this fortnight pleases souls of the ancestors, and redeems the person performing this ritual from the debt of ancestors. I am not competent enough to comment about the traditions of other religions and cultures, but I am sure similar traditions are practiced by the followers of other religions also.

The lesson for investors in this tradition is that "the feast" (gains from investment) will occur regardless of you. In case you want to enjoy the feast (gains), you need to survive (stay invested) till the market cycle turns; otherwise, the priests (savvy investors and traders) will savor the feast at your expense.

Tuesday, April 22, 2025

Focus on affordability quotient not inflation

The rate of Consumer Price Inflation (CPI) in India dropped to 3.34% in the month of March; below the lower bound (4%) of the regulator’s (RBI) target band of 4% to 6%. It is definitely a significant development insofar as the monetary policy consideration, macroeconomic stability, and consumer confidence are concerned.

If this trend sustains, it would pave the path for further easing in the monetary policy; improve the fiscal outlook; improve the outlook for debt and currency markets; aid corporate profitability and encourage fresh investment flows. In this sense, it is certainly good news for the investors in Indian financial markets in the near-term.

However, in my view, a low inflation rate does not help a large section of the Indian population much. A low inflation rate only implies a slower rise in the price level as compared to the prices in the base period. It offers no relief to the people who are already finding the existing prices of the essential goods and services unaffordable. A slower rise, not matched by a similar rise in wage level, just makes the living conditions even more challenging.

Apples at Rs300/kg and Mangoes @Rs180/kg are unaffordable for many middle-class households, even though their annual inflation rate may be close to zero.

Over the past two decades, nominal wage growth has often lagged or barely matched CPI inflation, especially for informal and unskilled workers. This has led to stagnant or declining real wages, exacerbating affordability challenges.

This trend, juxtaposed with poor new job creation, implies a further squeeze on the struggling middle class of India. The growth rate of private consumption, which constitutes approximately 60% of India’s GDP, will decelerate. Household savings which have cushioned the fiscal balance since independence, will erode even faster. A significant section of middle-class households may slither into a debt trap. Investment rate will deteriorate. The economy will get stuck in a vicious cycle of poor savings rate-low investment rate-lower economic growth-lower household income growth-poor savings rate.

Wage dynamics in India

As per the latest Annual Report (2023-24) of the periodic Labour Force Survey (PLFS):

· Labour Force Participation Rate (Ratio of workers employed and willing to work to the total population) in India is ~46%. The worker population ratio (WPR) is slightly lower at ~43%.

· Of the total Worker population (WP), 58% workers are self-employed (39% work on their own account and 19% family members helping these own account workers). Only 22% of WP is employed in a regular salaried job. ~20% of WP is casual workers.

· Regular wage workers (22% of WP) earn on average Rs700/day wage. Self employed workers earn on an average Rs463/day wage. Casual workers earn on an average Rs433/day wage.

· About 90% of WP is employed in the informal sector, with mostly undefined social security and poor job guarantee.

· Job creation has been a persistent challenge. The PLFS data shows unemployment rates hovering around 6–8% from 2017–2023, with youth unemployment (15–29 years) exceeding 15%. Formal job growth has been sluggish, with only ~10% of the workforce in organized sectors. The IT and services sectors, traditional middle-class job engines, face slowdowns due to automation and global competition.

· In the past decade or so, wages of the regular salaried employees have risen at 3.7% CAGR; while casual and self-employed have experienced 2-3% CAGR in their earnings. CPI index in the 2013-2025 period has risen at 5.5% CAGR. The affordability quotient of middle classes has obviously diminished.

It is pertinent to note that “Nominal wages grew faster (6–10%) in the 2000s due to MGNREGA and economic growth but slowed to 2–4% post-2015, lagging inflation.

Implications of diminishing affordability quotient

The combination of stagnant real wages and poor job creation has put a squeeze on middle-class disposable income, reducing their ability to consume and save. This is particularly acute for the lower middle class, who lack the financial cushion of wealthier households.

· Private Final Consumption Expenditure (PFCE) accounts for ~60% of India’s GDP. PFCE registered a growth rate of 6–7% in the 2000s and early 2010s. In the past five years PFCE growth rate has slowed to 4–5% due to economic shocks like demonetization, GST implementation, and the COVID-19 pandemic. Recent trends are indicating a recovery in consumption, with PFCE growth projected at 5–6% for FY25, driven by rural demand and government transfers. However, urban middle-class consumption continues to remain subdued.

Stagnant real incomes and high absolute prices (e.g., food, fuel, education) have adversely affected the discretionary consumption (e.g., durable goods, travel) of households. For example, automobile sales, a proxy for middle-class spending, grew only 2–3% annually post-COVID, reflecting affordability challenges.

· Household savings have been quintessential to India’s fiscal stability, financing investment, fiscal deficit and cushioning the current account deficit. Gross household savings averaged 20–25% of GDP in the 2000s but have since declined to 17–19%. Financial savings (e.g., bank deposits, mutual funds) have fallen from 10–12% of GDP in the early 2010s to ~7% in 2022–2023.

A sustained decline in household savings reduces the pool of domestic capital available for investment, increasing reliance on foreign inflows or government borrowing. This is straining India’s fiscal balance and public investment. Erosion of savings is also making middle-class households vulnerable to economic shocks.

· Household debt in India has risen steadily, from ~10% of GDP in the early 2000s to 40% by 2023. Retail loans (e.g., housing, personal, credit card debt) grew at 15–20% annually post-2015, far outpacing income growth. Middle-class households are increasingly relying on debt for housing, education, and consumption (e.g., EMIs for durables).

If real incomes stagnate and job creation lags, households may struggle to service debt, especially with rising interest rates. A debt trap would further erode savings, reduce consumption, and increase financial instability, as households divert income to debt repayment. This could also strain the banking sector, reducing credit availability for investment.

· Gross Fixed Capital Formation (GFCF), a measure of investment, averaged 30–32% of GDP in the 2000s and has fallen below 30% by 2024. In particular, corporate capex has remained slow, despite a variety of government incentives. Declining household savings has on one hand reduced the available domestic capital pool for investment; while on the other hand poor demand growth visibility is also discouraging new capacity building in many areas.

· Declining household savings has adversely affected bank deposits, constraining credit for small and medium enterprises (SMEs), a key investment driver. RBI data shows SME credit growth slowing to 10–12% from a high of 18-20%.

Conclusion

While low CPI is welcome, it does not address affordability issues. It is critical to not lose focus on managing the price situation and improve the affordability quotient of households. The urgency of implementing structural reforms cannot be emphasized more at this point in time.

Massive efforts and pragmatism are needed in the areas of agricultural productivity enhancements, education & skilling of workers, improving women workforce participation rate, making education, housing and healthcare costs affordable for households. A strong wage indexation mechanism could also help improve the affordability quotient.

Thursday, April 17, 2025

Looking beyond Mr. Bond

Continuing from yesterday…Mr. Bond no longer a superstar

Given my view that the yield curve is no longer a strong leading indicator, I prefer to use a mix of indicators to assess the likely direction of the markets. Mortgage rates, credit growth, credit terms, repo outstandings and the size of the central bank’s balance sheet are the most prominent ingredients in the mix I like to use.

For example, in the context of the US, Mortgage rates are a close pulse on borrowing costs, consumer behavior, and economic health, less abstracted than the yield curve. In the U.S., the 30-year fixed mortgage rate tracks loosely with the 10-year Treasury yield—historically about 1.5 to 2 percentage points higher—but it’s more than just a derivative. It folds in lender risk appetite, housing market dynamics, and Fed policy fallout in a way that hits Main Street directly.

Presently, mortgage rates are climbing—30-year fixed is around 6.8%, up from 6.4% in late March, shadowing that recent 10-year yield jump to 4.5%. That’s despite recession odds rising, which, one may assume, would pull rates down as safety bets pile into bonds. Instead, it’s signaling stubborn inflation expectations (CPI still above 3%) and maybe some lender jitters about defaults if the economy wobbles. Post-2008, mortgage rates have also been a better tell on how QE and rate hikes filter through—when the Fed bought $2.5 trillion in mortgage-backed securities, rates stayed low even as Treasuries twitched. The curve didn’t catch that nuance.

Mortgage trends usually sidestep central bank distortion. The Fed can pivot Treasury yields, but mortgage rates reflect a messier mix—banks’ funding costs, housing supply, wage growth. In 2022, the curve inverted, but mortgage rates soared from 3% to 7% clearly indicating “tightening ahead”.

Mortgage rates provide a frontline view of credit conditions and consumer stress—80% of U.S. household debt is tied to mortgages—without the Fed’s thumb on the scale.

Credit growth, credit terms and repo outstandings pair well with mortgage rates to assess the genuineness of demand supply equilibrium of the credit market. Together, they cut through the noise of central bank meddling and give a clearer view of whether demand and supply are truly balancing or just riding artificial waves.

Credit growth is the engine’s RPM. It tells you how much new borrowing—household, corporate, or government—is fueling the system. In the U.S., total credit to the private sector grew at a sluggish 2.5% annualized rate in Q1 2025, down from 4% in 2023, as per Fed data. That’s tepid, especially with mortgage rates at 6.8% crimping home loans—mortgage debt growth is barely 1% year-over-year. Meanwhile, consumer credit (credit cards, auto loans) is up 5%, hinting that people are leaning on short-term debt as housing gets pricier. If credit growth stalls while mortgage rates rise, it’s a sign demand’s weakening—banks aren’t lending, or borrowers aren’t biting.

Credit terms are the fine print—how tight or loose lenders are with the purse strings. Are banks demanding higher credit scores, bigger down payments, or jacking up spreads on corporate loans? Right now, the Fed’s Senior Loan Officer Survey (Q4 2024) shows tightening standards on commercial loans—net 15% of banks raised hurdles—while mortgage terms eased slightly, with down payment requirements dipping to 10% on average from 12% in 2023. High-yield bond spreads are at 350 basis points over Treasuries, up from 300 in January, signaling risk aversion. If terms toughen as mortgage rates climb, it’s a red flag—supply’s there, but lenders don’t trust demand to hold up.

Repo outstandings are the plumbing’s pressure gauge. The repurchase market shows how much short-term cash banks and funds need, and how willing they are to leverage. As of April 2025, U.S. repo volumes are hovering at $2.8 trillion daily, per NY Fed data, up 10% from last year. In a “genuine” equilibrium, repo would hum along smoothly, not swell like this while credit growth lags.

Mortgage rates at 6.8% look less alarming if credit’s flowing, terms are loose, and repo’s calm—demand and supply are moving in tandem. But slow credit growth, tightening terms, and repo pressure say the market’s strained—supply’s there, but demand’s shaky, and liquidity is a crutch. Central banks can twist yields all they want; these metrics show what’s really moving.

Central bank’s (CB) balance sheet is another key watchable for me. If CB takes too much paper on its own balance sheet, it indicates an attempt to unfairly influence the bond market equilibrium.

CB’s balance sheet is a massive lever they can pull to sway markets, and when it swells too much, it’s a flashing sign they’re trying to muscle the bond market into line rather than letting it find its own footing. As of April 9, 2025, the Fed’s balance sheet sits at about $7 trillion, down from its $8.9 trillion peak in mid-2022 but still a hefty chunk—roughly 25% of U.S. GDP.

Fed loading up on paper—mostly Treasuries ($4.3 trillion) and mortgage-backed securities ($2.3 trillion) as of late 2024—is a deliberate play to augment liquidity or cap yields.

In a free market, bond yields would reflect investor sentiment—fear of inflation, growth bets, default risks. But when the Fed gobbles up $95 billion a month or steps in with “emergency QE” like some predict if Treasury markets seize up again, it definitely distorts the equilibrium.

I use the classical 2:1 debt equity parameter used to benchmark the corporate balance sheets, to assess the central bank’s balance sheet also. I think M2 (Money Supply or Central Bank’s liabilities) should not be more than 2x of the assets on its balance sheet.

For context, in the US M2 money supply is close to US$21 trillion, versus the Fed’s assets of US$7trillion. That is a 3:1 debt equity ratio for the Fed. This implies excess liquidity from years of bond-buying ($4.3 trillion Treasuries, $2.3 trillion MBS on the Fed’s books). Pre-GFC M2 to Fed balance sheet ratio reached 8:1. Banks were churning out loans—subprime mortgages, leveraged buyouts, etc. —while the Fed’s balance sheet stayed lean, mostly short-term Treasuries. Reserves were minimal ($10 billion or so), and the fractional reserve system let M2 balloon. When the housing bubble popped, that 8:1 leverage meant there was no cushion—credit froze, banks choked, and the GFC happened.

Wednesday, April 16, 2025

Mr. Bond no longer a superstar

The conventional market wisdom suggests that the bonds usually lead the change in market cycles. Traditionally traders have closely followed the yield curve shape, benchmark (10 year) yields and high yield credit spreads to speculate the near term moves in equity, currency and commodity markets. Two simple reasons for this traditional practice are –

(i) Bond markets are usually more correlated with the economy.

(ii) Size of bond markets is materially larger than the equity, currency and commodity markets. It has the largest number of leveraged positions at any given point in time; and most of the large and influential market participants are more active in bond markets as compared to the other markets.

I am however inclined to disregard this piece of conventional wisdom. In my view, it would make sense only if the markets are operating in a free and fair manner. In cases where the central bankers and governments (through Sovereign Wealth Funds and other institutions controlled by it) actively and frequently intervene in the market, effectiveness of bond markets in leading the markets is impaired.

The world has definitely changed after the global financial crisis (GFC 2008-09). Central bankers, government, and public institutions are now playing significantly more active roles in the financial and commodity (especially gold and energy) markets. Bond prices are often influenced to suit the objectives of fiscal policy. Stock prices are influenced to suit political expediency.

Even pre-GFC, equity and bond traders did look at proxies like USD/CHF or copper—known as "Dr. Copper" for its economic sensitivity—for directional cues. In the past one decade we have seen Japan’s central bank buying equities; India’s government nudging markets via state-owned entities like LIC; the US Fed’s quantitative easing indirectly supporting massive amounts of stock buybacks; and Sovereign wealth funds in the Gulf Cooperation Council (GCC) countries piling into equities. This clearly indicates that in markets "no fixed formula works forever." Markets are adaptive. What held true for the past 35 years might not hold for the next 35.

US Bond yields no longer a lead indicator

In my view, the yield curve is fully relevant only if the market is free and genuine demand supply equilibrium of bond prices is discovered by the market forces. In situations where central bankers direct, manipulate or regulate yields, the yield curve is materially less important.

There is plenty of recent evidence, pointing that the US bond yields are no longer a strong indicator of the economy and/or markets. For example, consider the case of the US yield curve inversion in 2022-23.

Typically, an inverted yield curve—where short-term Treasury yields exceed long-term ones—has been a reliable harbinger of recession, preceding every U.S. downturn since the 1950s with a lag of roughly 6 to 18 months. The inversion that began in July 2022, peaking in mid-2023 with the 10-year/2-year spread hitting around -100 basis points, was the longest on record, lasting over two years. By historical standards, a recession should’ve hit by mid-to-late 2024. However, it has not happened; and the GDP growth held steady at 2.8% annualized in Q4 2024, and unemployment remains low at 4.1% as of March 2025.

Moreover, after un-inverting in September 2024—when the 2-year yield (around 3.6%) briefly dipped below the 10-year (around 3.8%)—yields have climbed across the board in the last two weeks. This morning, the 10-year yield is hovering near 4.5%, up from 4.0% in late March, while the 2-year has risen from 4.1% to about 4.5%. Incidentally, this rise coincides with a spike in recession odds, with the New York Fed’s yield curve model pegging the probability of a recession by mid-2026 at around 40%, up sharply from 25% a month ago. Normally, you’d expect yields to fall as recession fears mount, reflecting a flight to safety and anticipation of Fed rate cuts.

Prima facie, it appears that the bond market is more concerned about the rising inflationary expectations, particularly in light of the latest tariff policy of the US government. CPI is currently running above 3%—and there is skepticism about the Fed’s willingness to cut rates meaningfully from their current 4.75%-5.0% range. Higher yields also reflect a demand for more compensation amid uncertainty which could stoke inflation further. Arguably, the economy’s resilience—strong consumer spending, a robust labor market—may have also impaired the yield curve’s predictive edge this time. Structural shifts, like massive Fed balance sheet expansion since 2008 or global demand for long-term Treasuries, have certainly distorted its signal.

The recent yield rise despite recession odds implies that bond traders are betting on tighter policy or inflation risks, despite economic data flashing slowdown warnings (e.g., manufacturing PMI below 50 for months).

Conclusion: The yield curve’s relevance erodes when it’s less about market discovery and more about central bank glide path. Though it’s still worth watching, it’s no longer the king it once was in a freer market.

Tomorrow I will share my thoughts of what could be a better indicator, or aa mix of indicators to assess the likely market direction.

Wednesday, April 9, 2025

Tariff Tantrums – Where do we stand?

The global markets are shaken by the trade war initiated by the US by announcing arbitrary unilateral tariffs on all of its trade partners. Some large trade partners of the US, like China and EU, have reportedly threatened to join the war with full vigor, making the global market extremely jittery.

The prices of most risky assets and commodities have corrected sharply due to fear of widespread economic repercussions resulting in a global recession or even a depression like condition. The benchmark indices in most developed countries have corrected 8% to 18% in the past one month. Commodities, especially metals and energy, have also seen 7%-15% cut.

In my view, it may be a little early to assess the short-term impact of the latest events. Things are evolving fast and chances are that better sense would prevail and leaderships of the US and its trade partners would be able to prevent the current stalemate from becoming a game of ego between them; and arrive at a mutually agreed solution. Millions of research reports and several hours of media commentaries, analyzing the short-term impact of the latest tariff war, have already happened. I am in no position to add anything more meaningful.

However, if the situation does deteriorate and more people begin to think like Prime Ministers of Singapore (watch here) and the UK (read here), the global ‘reset’, we have been talking about since the global financial crisis (GFC: 2008-10), may take a tangible shape much sooner than presently anticipated. It is critical to make an assessment where would India stand in the new global order, if it were to take shape in the decade or so.

The impact of the GFC on financial markets was mitigated in a couple of years by collective efforts of the governments and central bankers. However, the social, geo political and economic impacts of the crisis largely remain unmitigated.

The "Reset" button pressed by the crisis has resulted in widening of socio-economic divide across the world. The geo political tensions have intensified materially. The rise in protectionism has adversely impacted global trade. The rising unemployment in Europe and most commodity dependent economies in Asia, Africa and Latin America, declining growth in China, substantial cut in developmental aid to least developed nations due to fiscal pressures, has caused widespread human suffering for over a decade now.

The onslaught of novel coronavirus (COVID-19) and Russian invasion of Ukraine, has accelerated the "Reset" process. I have written this before, but it would be in order to reiterate a brief account of the changes in world order that have taken place since the advent of the 20th century.

In 1917, the Russian revolution successfully dismantled the Tsarist autocracy and laid the foundation of the USSR. In the following decades, many smaller independent European states became subservient to a mighty Russian socialist army, and together formed one pole in the emerging bi-polar world, forever shrouded by the specter of cold war.

In the same year, the USA decided to join the War as an associate of the Allies - a development that tilted the scale in favor of the Allies, bringing the War to an end in 1918. In the following decades, the USA emerged as a formidable military and economic power, and led the democratic allies to become the second pole in the emerging bi-polar world.

The imperialist global order that existed in the preceding centuries began to dismantle. Many colonies of the European empires gained freedom. The British Empire that was built in three centuries and covered almost one fourth of the world population and area before the War, was completely dismantled in the following three decades. In these three decades (1918-1950), a new world order acquired a concrete shape. For the first time in modern history, the world adopted a rule-based order, characterized by multilateral agreements and institutions like the UN, NATO, WARSAW Pact, GATT, NAM, Bretton Woods, World Bank, energy cartel (OPEC), et. al. Mao, Israel, and the Cold War were key interludes in the main play. This world order lasted for about four decades.

The German Wall fell and the USSR disintegrated in early 1990s. This unleashed a new wave of globalization in a world dominated by just one superpower – the USA. Global Trade (WTO), Internet, dematerialization of assets, Europe integration into a single market, China's entry into mainstream global trade (through WTO), free flow of capital, G-20, BRICS, numerous FTAs, global war on Islamic fundamentalism, energy security, climate control and global financial crisis, dominated this phase.

Cracks started to emerge in the global order after GFC. The global economic behemoth China started to express its global ambitions in terms of domination over trade, technology and territories. Russia, which had become a dominant player in the global energy market, also expressed its ambitions. Both these countries now led by unchallenged, ambitious, and strong leaders were openly challenging the US hegemony; and looking for a rightful place for themselves in the global order.

In the past five years, the outbreak of a global pandemic and Russian invasion of Ukraine has accelerated the process of a reset in the global order. As things stand today, we could have a concrete shape of the new order emerging in the next 5-10 years. I personally do not believe that the emerging world order will be based on isolationism, parochialism, localization of trade and closed borders. Though smaller trade blocs, more regional blocs like the European Union, neutral currencies, and redrawn global maps may be some of the key features of such an order.

A more relevant point is where does India stand in this critical transition? I would share my thoughts on this next week.

Tuesday, April 8, 2025

Tariff Tantrums

Last week, President Trump announced a hike/imposition of tariffs on most of the USA's imports. As per the proposed tariffs that are presently scheduled to come fully into effect from 9^th April 2025, the Trump administration has proposed a 10% base tariff on all imports into the US. Over and above the base tariff, higher rates of tariff are applicable on several countries based on the trade deficit of the US with each such country.

The global reaction to the tariff announcement has been varied. Some trade partners like China have responded aggressively by announcing matching higher tariffs; whereas the others, like India, have adopted a wait and watch approach, hoping to find a middle path.

Apparently, the calculation of the proposed indiscriminate tariffs has been done through mindless spreadsheet application, using the recent US trade data. Though President Trump had made tariffs a key issue in his poll campaign, the administration appears mostly unprepared for this. The explanation offered by the US administration for taking steps is not convincing. For example, the arguments presented in an interview of treasury secretary Scott Bessant, remind of an old folklore that goes like this:

“Once a little lamb walked to the river to quench his thirst. At that time the king of the jungle, a Lion, was also drinking water from the river a few meters upstream of the lamb. The smell of this small soft lamb whetted lion’s appetite. He wanted to eat the lamb immediately, but the farce of being a just and kind king, he has perseveringly created over years, prompted him to look for a valid excuse to kill this small creature.

After thinking for a moment, he roared "How dare you make me drink dirty water?”. Not sensing the trouble, the lamb politely replied, my Lord, I am downstream, while you are drinking water upstream. It is me who is drinking your dirty water!”

Determined to kill the lamb, the lion retorted, “but why did you laugh at me last summer when I passed by your abode?". Now sensing some trouble, the lamb meekly replied, "My lord, it could not be me, because I was only born just a couple of months ago”. Unable to control his urge, the lion lamented, “If it was not you, it must be your mother. You must pay for her sins.” Saying this he jumped on the lamb and killed him.”

A career hedge fund manager, who has been feasting on the miseries of others all through his adult life, suddenly speaking the language of Karl Marx, and rooting for the hungry and homeless, would make sense only if he wears the rob of a monk and speaks from a monastery. It sounds even more unconvincing when seen in tandem with the DOGE’s move to end humanitarian aid, in some cases a couple of million dollars, to the world’s most poor and disease prone people.

Listening to President Trump and his team members, I get a vivid impression that Tariff tantrums they are throwing are just an ill-thought excuse being used for a bigger design. This is clearly a fight to stay relevant in the emerging world order. The US economics and demographics do not support its pole position in global geopolitics – a position they have enjoyed and greatly benefitted from for over 80 years now.

The US gained its pole position by dropping “Fat Man” (Nagasaki) and “Little Boy” (Hiroshima), eighty years ago, and has been repeatedly shocking the global community through economic, financial and geopolitical shocks to retain this position. The latest tariff tantrums may just be part of that series.

I do not subscribe to the conspiracy theory doing rounds on social media that this may just be a ploy to push the US yields down, to ease the fiscal pressure and facilitate smooth refinancing of the debt maturing in the next couple of years, for three simple reasons:

(i) The US mostly borrows in its own currency. A simple quantitative easing (USD printing) would be sufficient to refinance debt.

(ii) Bond yields are mostly a function of demand and supply for the underlying bonds. Tariff war would certainly weaken the US economy - at least in the short term (2-3years), if not structurally. Besides, it will also trade linkages of the US. Weaker growth (weaker USD) and declining external linkages would invariably result in poor demand for bonds, hence higher yields. To the contrary, a strong economy with contained inflation (cheaper imports) and stronger external linkages is more likely to stimulate higher demand for the US bond and hence lower yields.

(iii) Approximately, one third of the US public debt (US$8-9 trillion) is owned by the foreign entities. Out of this, Japan (US$1.1 trillion) China (US$800bn) and the UK (US$700bn) are major holders of the US debt (US Treasuries). A full-fledged trade war could result in these holders optimizing their UST holdings and might further reduce demand for the US debt.

There is also a serious disconnect between the immigration policies and the objective to make the US a manufacturing power again. The US wage structure, average US citizen skill levels, the cost of imported raw material and capital goods post tariffs, and a weaker USD may not be conducive for an efficient manufacturing ecosystem. The US would need cheap foreign labor, strong USD, strong trade linkages with suppliers of raw material and engineering goods for at least one decade to relocate manufacturing back to the US.

Notwithstanding the brouhaha over the US$5mn gold card, in the absence of an assurance of a free, liberal, diversified, inclusive and equitable society and stable policy environment, not many investors and highly talented workers may find the US a suitable investment/career/study destination. The European competitors may be happy to host these investors/workers.

In my view, Trump’s tariff tantrums are part of the traditional US ‘shock and awe’ tactics. They will test waters with this sometimes and stage a strategic retreat, if it does not show the desired effects, viz., reinforce the US position as undisputed superpower; achieve fiscal correction without triggering a deeper demand recession, and probability of putting Trump’s face on the Mount Rushmore. However, if it does show the desired results, no one should have any strong reasons for worrying.

In the worst case, if the US stays committed to tariffs and its trade partners prefer to contest rather than yield, we must be prepared for the end of the rule-based global order that has prevailed since the end of WWII. The age of Vikings returns. All powerful nations begin campaigns to acquire territories and resources. The weak nations get subjugated. Poor and starving people are made slaves. Indentured laborers would rebuild empires, before the disease and death destroys it all.

In this context, it is important to listen to the warning of the Prime Minister of Singapore.