Do it yourself

The behavior of Global markets has always been perplexing for the participants. The past 8-9 months have been no different in that sense. Stock prices, commodities, cryptos, bonds, and precious metals have all moved higher; in many cases without a fundamental case for such an upmove.

The script in the US is playing mostly on the expected lines (see here and here).

Department of Government Efficiency (DOGE) – crash landing

Department of Government Efficiency (DOGE) is apparently on its way to crash land, with the pilot (Elon Musk) ejecting himself out shortly after taking off.

DOGE’s actions have faced multiple lawsuits, with critics arguing that Musk and his team have violated federal laws, union agreements, and civil service protections. A federal judge halted parts of USAID’s shutdown, and courts have restricted DOGE’s access to payment systems.

Despite Musk’s goal to cut $2 trillion from the federal budget, 2025 spending is slightly up from 2024, per Brookings Institution data.

Mandatory spending (e.g., Social Security, Medicare) limits achievable cuts. Over two million federal employees were offered buyout deals, with some agencies facing mass layoffs. However, some fired staff have been rehired, indicating implementation challenges.

Though DOGE has made a significant promise, the actual delivery has been materially lower, primarily due to legal, ethical, and practical challenges; mixed public support and limited measurable impact. With Musk virtually leaving the initiative, its future appears uncertain.

Fiscal deficit – continues to rise

The U.S. fiscal deficit is on an upward trajectory, driven by increased spending, rising interest costs, and insufficient revenue growth.

For the first seven months of fiscal year 2025 (through April 2025), the cumulative deficit was $194 billion higher than the same period in the previous year. Total outlays for this period were $4.2 trillion, up $340 billion from the previous year, driven by increases in Social Security ($70 billion), net interest ($65 billion), and Medicare ($41 billion)

The Congressional Budget Office (CBO) projects the federal budget deficit to be $1.9 trillion in fiscal year 2025, equivalent to 6.2% of GDP. By 2034, the deficit is expected to grow to $2.8 trillion (6.9% of GDP) if current policies remain unchanged.

Recent legislative proposals, such as the tax and spending bill passed by the House in May 2025, could add $3.3–$3.8 trillion to the federal debt over the next few years, further exacerbating the deficit. Federal debt held by the public is projected to rise from 100% of GDP in 2025 to 118% by 2035, surpassing the historical high of 106% set in 1946.

The US sovereign credit rating has been cut by Moody’s Aa1 from AAA earlier.

Tariff Tantrums – More pain than gains

The tariff war initiated by the Trump 2.0 administration in February 2025, has mostly been counterproductive so far.

New tariffs have generated a short-term revenue ($16 billion in April alone) but at a significant cost - A 6–8% GDP reduction in the long run as per The Penn Wharton Budget Model (PWBM); 2.3% higher consumer prices; losses to the US households; global trade contraction by 5%; U.S.-China trade nearly collapsing; retaliatory tariffs and supply chain disruptions exacerbating economic strain, particularly for U.S. consumers and export-heavy sectors.

The net effect is a significant economic burden on the U.S., with global ripple effects, though temporary truces (e.g., U.S.-China) and exemptions (e.g., USMCA) mitigate some damage.

Seemingly unconventional approach of the President may be turning the US strategic allies into adversaries. Frequent and unpredictable tariff tantrums of President Trump, have widened the trust deficit between traditional trade partners of the US (e.g., the EU, Britain and Japan), making the relationships purely transactional.

USD weaker, yield higher

The tariff war has imposed significant duties (e.g., 20–145% on Chinese imports, 25% on steel, aluminum, and autos from Canada and Mexico). These tariffs raise the cost of imported goods, increasing inflationary pressures. For example, the two-year breakeven inflation rate rose from 2.54% at the end of 2024 to 3.36% by April 8, 2025, reflecting market expectations of higher short-term inflation.

Rising inflationary expectations, fiscal debt and debt sustainability concerns (rating downgrade) have prompted the bond investors to demand higher yields. As Minneapolis Fed President Neel Kashkari noted, rising yields and a falling U.S. dollar suggest investors may be viewing the U.S. as less attractive due to trade war escalation and fiscal concerns, reducing demand for Treasuries as a safe-haven asset.

The US Fed is also sounding more hawkish in its recent statements, impacting the traders’ and investors’ sentiments.

The U.S. dollar (USD) has also been weakening in 2025, with the Dollar Index (DXY) dropping from 108.2 in late December 2024 to around 100, a decline of approximately 7%. This weakening of the USD is driven by multiple interconnected factors, e.g., the rising U.S. fiscal deficit, the tariff war, rising U.S. Treasury bond yields, and failure of the Department of Government Efficiency (DOGE) to implement material spending cuts.

I still believe that the conventional wisdom will prevail, tempers will cool down and President Trump will eventually return to the path of reconciliation and cooperation. Nonetheless, it is still uncertain how much damage would have already been caused by then.

Also read

“MAGA” – Keeping it simple

The master failing the first test

View from the Mars

View from the Mars - 2

Tariff Tantrums

“Trade” over “War”

Reportedly, Israel and Hezbollah (Lebanon) have successfully negotiated a 60 days ceasefire to the latest round of hostilities which started with Israeli forces invading Lebanon on the 1^st October 2024. The deal involves withdrawal of Israeli troops from Lebanon and deployment of a UN peacekeeping mission and establishment of a US led international monitoring group.

This is an important development in global geopolitics. The Hezbollah group was overtly supported by the Iranian government. Israeli invasion into Lebanon had evoked a direct military response from Iran; threatening a much wider escalation of a hitherto localized Israel-Palestine conflict. The ceasefire deal, which has been welcomed by Iran, diminishes the probability of an immediate wider escalation of the Israel-Palestine conflict. However, since the deal does not cover the ongoing Israeli attacks in Gaza Strip, it does not offer any durable mitigation of the threat.

If the outgoing president Biden could pursue Ukrainian president Zelensky to also negotiate a similar ceasefire deal with Russia, it would be considered a great parting gift for the president-elect Trump.

From the economics viewpoint, presence of the UN peacekeepers on the ground and direct involvement of the US in the region may temporarily help in restoring normalcy in the Red Sea marine traffic, thus normalizing the global trade to a certain extent; and the volatility in oil prices may also subside. A restrained approach from both sides would provide a durable solution.

This is definitely good news for India. An uncertain and volatile oil price environment, higher logistic cost due to disruption in the Red Sea, and a conflict involving Israel (supported by the US) and Iran (supported by Russia and China) are investors and policymakers’ nightmares.

Another thing that may be of immense interest to the Indian investors presently is Scott Bessent’s (Trump’s designated treasury secretary) views on USD and US treasury yields. As a hedge fund manager, Scott has preferred a weaker USD strategy, against raising tariff barriers, for the US manufacturing renaissance. Scott believes “tariffs are inflationary and in turn would strengthen USD. On the other hand, a weaker USD would make US manufacturing competitive. A weak dollar and plentiful, cheap energy could power a boom. A stronger USD should emerge only at a later stage if the US reshoring effort is successful”.

It may not be great news for the global hedge fund managers who are overwhelmingly long USD. As per the recent survey, presently, long USD is the most crowded trade globally.

If Scott sticks to his extant views, we may see USD weakening, US yields falling and US energy production & exports rising in 2025. This trifecta may delight Indian markets and our emerging market peers.

One question that begs the answer is “against what USD will weaken?” The US Fed is not keen to cut rates materially from the current levels. EUR cannot afford any strength, especially when German and French economies are tethering. Both China and Japan have shown no inclination to leave their currencies to the market forces. Strength in emerging currencies, including INR, is like a tiny insect bite for an elephant like USD; makes no difference. A peaceful middle east and Europe and cheap energy may take much of the shine out of gold.

I would be pleased to hear the views of readers on what would USD weaken against, if it does?

Economists, monetary policy experts and market commentators have been talking about the dilemma the Bank of Japan (BoJ) is facing for the past few months. As the BoJ simultaneously fights both the inflationary and deflationary pressures in the Japanese, it finds striking a balance between JPY exchange rate and Japan Government treasury bonds (JGT) yields a big challenge.

The Japanese economy has been facing a deflationary trend for more than three decades. After the global financial crisis, the trend accentuated further. In 2016, the Japanese authorities decided to trigger inflation by keeping policy rates below zero. Massive “free money” was pumped in the economy to boost economic activity by achieving a sustained inflation rate of 2%.

Consequent to the ultraloose monetary policy, the debt in Japan has swelled to 250% of GDP. It was not a major problem till the major trading partners like the US were also keeping the interest rates close to zero and following an expansionary monetary policy. However, once the US Fed started to unwind the monetary stimulus by hiking rates and tightening money supply, the yield differential between the US treasuries (UST) and JGT started to rise. This has put pressure on JPY, pushing it to the lowest level vs USD in three decades.

A weaker JPY makes Japanese imports expensive, raising a threat of runaway inflation that may force the Japanese authorities to hike the policy rates and tighten the money, pushing the economy back into deflationary abyss.

This is not the kind of situation BoJ has envisaged in its policy deliberations. They wanted a sustained 2% inflation primarily driven by improvement in growth trajectory led by rise in demand and higher wages. Instead, the specter of inflation is looming due to weakness in JPY and higher energy cost.

The BoJ faces a dilemma – whether to allow bond yields to go higher by hiking policy rates and protect JPY to check imported inflation; or protect low bond yields and counter JPY sell off through aggressive market intervention and other market and policy tools.

Allowing bond yields to go higher in tandem with UST yields, may severely impact the fiscal balance as the interest liabilities of the government would rise sharply. Allowing JPY to weaken further may push the economy deep into stagflation. Continued market intervention to protect
JPY (QE), will increase the money supply further and extend the deflationary trend seen since 1990s.

 

While BoJ endeavors to resolve its dilemma, the following questions would need deeper examination.

1.    Could the US Fed also face a similar situation in the next few years?

2.    Does “unlimited QE” actually has limits?

3.    Have developed economies already hit the wall in terms of fiscal leverage?

 There are lots of events happening in global markets which cannot be full explained through conventional wisdom or empirical evidence. In my view, lot of these events are unintended consequences of policy actions, geopolitics and trade conflicts.

For example, there is a massive rally in the global commodity prices, despite poor demand and growth outlook for next few years at least. The recovery to pre Covid level may not entirely explain the rise in commodity prices much beyond the 2019 levels. Popularization of electric mobility etc. can explain gains in some commodities, but not in steel, coal, crude etc.

The forecasts of a commodity super cycle sound mostly unconvincing, given (i) worsening demographics of the world; (b) restricted mobility; (c) seriously impeded purchasing power of people; (d) already stretched limits and diminishing marginal utility of fiscal and monetary stimulus; (e) technology evolution focusing on reversal of trends in labor migration; and (f) diminishing chances of a full-fledged physical war amongst large countries; etc.

Material changes technologies related to construction, manufacturing and transportation etc. also leading to material changes in the demand matrix for various commodities like steel, cement, copper, coal etc.

The outrageous rise in economic inequalities globally also mean that investment rate in poor countries will continue to decline for next many years, as the economic power gets more and more concentrated in the hands of few rich nations.

I therefore feel that the price trends in the global markets are deeply influenced by the factors other than economics. Even though the defeat of Donald Trump in US presidential elections has taken the trade conflicts away from headlines and front pages; the trade war that started few years ago is far from over. Besides, geopolitics is also playing a large role in global markets.

In past two years, China has been making conscious efforts to reduce its holdings of US Treasuries and building large reserves of physical industrial commodities. The global investors appear selling Chinese assets (leading to massive tech rout in China) and buying other emerging markets, in line with the global enterprises’ China+1 policy.

The unintended consequences are that world is facing shortages of rare earths, semi-conductors, and shipping containers and struggling with the rising prices of commodities. China which had been exporting deflation to the world for the past 10years has suddenly become exporter of inflation to the world.

The markets focusing more on US yields and USD cross rates, might be missing the point that Chinese aggression on commodities can derail the entire AI led Tech revolution for at least 4-5yrs, if it continues to choke supply of rare earths and semi-conductors. This derailment of global trade and therefore growth is a bigger worry than inflation at this point in time.

It is pertinent to note in this context that today China is hosting its annual gathering of National People’s Congress, its biggest political meeting, to approve the plan to propel Chinese economy to the top of the world, ahead of US. At the center of the new plan will be Beijing’s push to develop new technologies and cut the nation’s reliance on geopolitical rivals such as the U.S. for components like microchips. As per some experts, that should mean allocating more resources to science and technology, with spending on research and development targeted at around 3.5% of GDP over the period

Another case in point is the sharp rise in the price of sugar in global markets. This rise has occurred despite the higher than expected production in India and over 10.6MT carry over stock. But for MSP of Rs31/kg mandated by the government, the glut should have resulted in domestic prices falling to much below the cost of production. Also, but for export limitations and logistic constraints, Indian supplies could bring down the global prices to much lower levels. Visualizing this as signs of impending global food inflation cycle may not be appropriate.

The semi-conductor shortages are hurting manufacturing of white goods, electronic items and automobile, etc. This could have meaningful second round impact on other sectors of economy. Thankfully, the border conflicts and political rhetoric have not impacted the Indo-China trade materially. But India gaining advantage at the expense of China due to China+1 policy could have some repercussions in the short to medium term. The capacity building in India needs to take place now. A delay of even one year could potentially render much of this capacity redundant as global enterprises find alternatives or reconcile with China.

The short point is that US bond yields and USD exchange rate, etc. are least of the worries for our markets and economy, presently. Laying too much focus on these may only distract us from bigger threats and even bigger opportunities.