Sorry I disappeared from Substack for a good while but markets are crazy, the fund is growing nicely and it’s a huge amount of work.

But no worries - I am back with a healthy dose of macro analysis for you.

As an exception to the norm and to gain back brownie points with you guys, I am sharing the latest research piece reserved to the investors and The Macro Compass subscribers.

Here it goes!

Forward-looking indicators suggest the US nominal growth cycle is picking up pace again. The inflation-adjusted primary US fiscal spending is higher than in 2024-2025 at this point of the year:

Global real-economy money printing is also growing at a strong pace, similar to 2025.

As a reminder, inflationary money is printed by governments (deficits) and via credit creation (banks, shadow banks etc). Concerted G20 fiscal deficits and the debt-funded AI capex cycle are the main contributors to the strong pace of global money printing in 2026:

Leading indicators also suggest the US labor market has found a bottom.

The NY Fed probability of finding a job in the next 3 months (orange) has stabilized and the weekly ADP job creation series (blue) has moved from -50k in June 2025 to +42k today.

As a reminder, with the US labor force growth (e.g. supply side of labor market) estimated to be close to zero it doesn’t take much demand for labor to kickstart a virtuous cycle in the US job market:

A virtuous cycle in the US job market won’t necessarily mean runaway inflation, at least in the short term. While a tighter job market will heat up wages, the starting point for US wage growth is very modest:

The Fed’s dual mandate of a) not letting the job market fall apart and b) core inflation below 3% (yes, sorry, not going to pretend the Fed has a 2% target anymore) would now call for a different reaction function.

‘’Would’’ is the key word here.

The December Fed meeting is now priced at a robust probability the Fed will hike. Yet to hike rates, the FOMC needs a majority of voters to lean in.

There are 12 voters, and a 6-6 situation gives the FOMC Chair the power to break the tie.

And the new FOMC Chair was recently talking about shrinking the balance sheet as a cover to cut rates and moving the inflation benchmark from core PCE to trimmed mean PCE (you guessed it, trimmed mean PCE is lower than core PCE)…it’s safe to say Warsh would rather eat his hat than raise rates.

In other words, you’d need 7 FOMC members voting for a hike to actually get a hike.

Even assuming the 3 dissenters against the dovish language in May would outright vote for a hike, and Barr would join them (quite some assumptions already!), you need 4 more votes for a hike coming out of this group: Warsh, Williams, Powell, Cook, Bowman, Waller, Paulson, Jefferson.

Yes, the BoE-zation of the FOMC is upon us. But I don’t think the FOMC will have a majority ready to hike any time soon.

Now, let’s assume my analysis holds. We would then find ourselves in the following situation:

• US money printing is accelerating, and global money printing remains strong;

• Nominal growth is likely to pick up;

• The US labor market seems to have found a bottom, and might accelerate soon;

• On the margin, this would add to inflationary pressures (but no runaway inflation dynamics yet);

• The standard reaction function from the Fed should be to move to hikes (and the market asking for it);

• The Fed is unlikely to have a majority actually voting for hikes any time soon;

• So the title of the movie might be: Run It Hot, Yet Again

In that macro setup, my 40-year backtest shows the best trades to own are:

1. High-beta equities (small cap, EM, value tilt)

2. High-beta commodities (silver, copper, but also gold)

3. Long cyclical and high-yielding FX, short defensive tilt FX (e.g. ZARJPY)

4. Curve steepeners, short long bonds

I was recently in London meeting 3 large macro pod shops, and when presenting this thesis the biggest pushback or complete lack of interest sits with a) gold b) small cap, value, EM equities.

And that’s either a function of the AI dominance in equities recently or the ‘’it’s going nowhere’’ factor in precious metals such as gold and silver.

Option market positioning shows the same lack of interest towards gold upside. For the first time in many many years, 25-delta gold calls are trading at a discount to 25-delta gold puts. Investors are more interested in protecting against another drop in gold rather than buying gold upside:

Yes, I know: Hormuz. All the above is irrelevant if you think we escalate the war or there is no fix for months.

But if we unlock energy flows, we will Run It Hot. And the market is not fully prepared for it.

Thanks for reading!

To be in touch with me: alf@palinurocapital.com

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Warsh is the new Fed Chair.

I find it hilarious that people are calling him a hawk based on what he did 10-15 years ago. This is like looking at old pics of me with a head full of hair (still have one of these on LinkedIn!). These times are long gone.

Jokes aside, I spent hours listening to the most recent interviews Warsh did (here and here, for example).

Here are the most consequential thoughts he shared:

1) Inflation is a choice, money creation drives it (as per Friedman, and that’s true in most cases);

2) Fed is backstop for banking system, but needs to get out when job is done (fair);

3) He believes inflationary money is created equally by Fed and the government (absolutely false: fiscal deficits create inflationary money, Fed monetary operations such as QE only create bank reserves);

4) He believes the Fed balance sheet being so big ‘’crowds out the private sector’‘ (absolutely false: the private sector uses another form of money i.e. bank deposits, there is no ‘’crowding out’’ of anything);

5) Need to get out of the ‘’fiscal and monetary’‘ mess inherited: a lot of talk about interest expense > defense spending (ok, so hear the plan now...);

6) ‘’If we would run the printing press a little quieter, we would have lower interest rates’’;

7) The plan is to shrink the Fed balance sheet, so we get lower rates, so private sector can thrive = higher economic growth (he is looking at the wrong printing press – Bessent has the key one, not the Fed);

8) Rates should also be lower because we are on the verge of a productivity boom (his opinion, fair enough);

9) The Fed should not be data dependent, data is revised all the time, why be? Best to have an opinion and stick to it. Also the Fed should not share economic forecasts, no dots. No forward guidance (uncertainty up).

It’s pretty clear Warsh – as many others, by the way – gets money creation wrong. But it still leads to some key consequences for markets:

• Shrinking the balance sheet and following the AI productivity fairytale will be two convenient covers Warsh will use to push for cutting Fed Funds further;

• Cutting front-end rates further will help the US Dollar remain weak;

• Injecting instability in the repo market through a reduction of the balance sheet, cutting front-end rates proactively and slashing forward guidance tools = uncertainty up = steeper curves.

One key thing to consider is that if Warsh would manage to shrink the Fed balance sheet, this could have an impact on the repo market.

The chart below shows how bank reserves as % of total US nominal GDP have been shrinking and approaching the potentially dangerous 8-9% level – last time it breached that, we had a repo blowup in 2019.

This is because bank reserves are very unevenly distributed across US banks, and once they start becoming scarce the odds of interbank liquidity drying up for smaller banks increase:

Do you know who put forward this ratio, by the way?

Waller! (Read his speech here).

Shrinking the balance sheet further here would put the stability of the repo market at risk, and by the way in December 2025 the Fed resumed purchases of T-Bills with the very intent to avoid such risks (here).

The odds of Warsh convincing his colleagues to shrink the balance sheet further here are low.

But now let’s assume that Warsh still manages to put through his lower balance sheet + AI productivity fairytale to convince his colleagues to cut rates a bit faster. And that forward guidance disappears.

Then the US yield curve would steepen, and that goes against what the US administration wants:

Wait, why am I showing you a chart of 30-year JGBs against 30-year US yields for Japanese investors?

Because this is a key chart for Bessent to push in the right direction, as it would achieve a great deal of positive outcomes for the US administration.

For years, Japanese investors have bought foreign bonds WITHOUT hedging the FX risk at all - and why?

Because the assumption was that the Yen was going to get weaker, and hence Japanese investors could:

1) Get a higher yield in foreign bond markets;

2) Benefit from the JPY weakness on top.

And it’s in the clear interest of the US administration to reverse this mechanism.

Getting Japanese investors to buy more JGBs would encourage repatriation of capital and help JPY appreciate, plus support the Japanese bond market and help global long-end bond yields stabilize.

Very soon, it might be that Japanese investors wouldn’t really have any advantage in buying 30-year US Treasuries (after FX hedging costs) rather than keeping money in Japanese bonds.

A steeper US curve would bring Japanese investors into the old habits, and that’s not what the US wants.

So, here we are trying to solve the puzzle.

We have Warsh likely using Fed balance sheet reductions and the AI productivity story to cut rates.

Unlikely to really succeed, but the bias will be for a dovish Fed (what a surprise!).

That helps the USD to weaken and equities to go up (two clear US admin objectives), but Warsh is a curve steepener – and if long-end bonds get out of hand, Bessent and Japan could be ready to intervene.

Bessent can tweak issuance further to the front-end, and Japan can backstop its own long-end bonds too.

This leaves us in a scenario where in the medium term:

• We keep running the global economies hot via major fiscal spending programs worldwide;

• The Fed maintains a dovish inclination;

• Bond yields are flat or down;

• The USD trades flat or down;

• Commodities and equities maintain the most upside convexity

I believe the asset classes poised to deliver the best risk-adjusted returns over the next 3-6 months are:

• International, value-oriented stock markets (e.g. Europe, Japan, Canada, specific Emerging Markets);

• Precious metals and industrial commodities (e.g. Copper).

This was it for today. Thanks for reading.

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‘’I compile statistics on my traders. My best trader makes money only 63 percent of the time. Most traders make money only in the 50 to 55 percent range. That means you’re going to be wrong a lot. If that’s the case, you better be sure your losses are as small as they can be, and that your winners are bigger.’’ – Steve Cohen.

This is a hard truth to accept for many macro investors: we will be right only about 50-55% of the times.

If your win rate is much higher than this, I suggest you extend the sample of trades you are analyzing or assess whether you are not trading macro but rather just selling optionality – short vol/option strategies have win rates as high as 90%+, but they wipe you out completely when you are wrong.

In the last 10 years, I scored a 53% long-term win rate on my directional macro trades.

Once I realized that and given that the year-end P&L formula can be written as follows:

I knew I’d better make sure the size of my losses doesn’t get out of control.

This can be achieved in two ways: sizing trades correctly and designing a system that lets your winners run.

Here is what I go through for every tactical trade I set up:

Points 1-3 keep my emotions in check and ground me to a more rational assessment of the trade.

Points 4-6 are about implementation.

A warning: short carry trades (and long options) are expensive to hold over time if nothing happens.

A reminder: in very choppy markets, you can get quickly stopped out with linear trades even if your thesis proves to be correct – consider whether the market regime favors linear or option implementations.

Don’t be stupid: check whether the trade you are about to add is not just another expression of a trade you already have on – I have seen people blow up as the 10 trades they were running were just…the same trade.

But it’s point 7 that sticks out: sizing and risk management define most of your P&L at year-end.

Here is how I approach them through a practical example.

Say you think that the S&P500 will keep marching higher over the next month: how many SPYs do you buy?

You could be in the right or left 50% of that distribution: when you pull the trigger, you don’t know that.

And because you don’t know that, you want to standardize your ex-ante sizing.

One effective way to standardize the sizing of each tactical trade so that they don’t excessively weigh on your year-end P&L is to do volatility-adjusted sizing: let’s go through the SPY example.

Let’s set our stop at 1.5 standard deviations, and our defined time horizon in this example will be 1 month.

For the SPY, using a 5-year lookback the typical 1.5x monthly negative sigma event would be a -7.6% decline.

You can play around with the lookback period if you want more history and/or assign different weight to more recent periods if you think today’s vol regime is more relevant (grey boxes).

If returns are normally distributed, we will be stopped out 6.7% of the times in our defined time horizon.

But as returns often follow other distributions, it’s good practice to check the actual empirical probability of being stopped out against the theoretical 6.7% probability (orange boxes).

Finally, define what’s the fixed % of AuM you are willing to lose on any given macro trade.

A fictitious $1 million trading account willing to lose max $20k per trade which is bullish on SPY with a 1-month horizon would buy 571 SPY shares at $437 and be stopped out at $402 (-7.6% = 1.5x sigma event) hence losing $20k (= 2% of AuM).

Congratulations, you just applied volatility-adjusted position sizing!

What are the advantages of this approach?

1) You remain agnostic to ‘’volatility luck’’: if you size all positions the same, being right/wrong on the most volatile assets will make/break your P&L at year-end and that’s all about luck. Don’t gamble.

2) You remain agnostic to your ‘’conviction’’ level: the truth is that ex-ante you don’t know when you’ll be in the right or wrong 50%, so why would you over or under size a trade based on your ex-ante conviction levels? You shouldn’t.

3) This approach is really flexible: you can use it as a day trader or as a tactical macro investor, you can set stops looser/tighter depending on your approach etc.

Ok so now you have a data-driven macro approach, tools to help you digest action in global markets, and a ‘’don’t be stupid checklist’’ to help you push that 50% win rate higher plus a vol-adjusted position sizing system to avoid big losses by design.

How do you actually make money?

First, you place profit targets in an asymmetric way to your stop losses.

If your stop loss is at -1 standard deviation, your profit targets should be at over 1 sigma: if you are able to preserve a 50% win rate, that will help you making more money on winners than you lose on bad trades.

Most importantly though, you must have a system in place to let your winners run: the best hedge fund traders I know only score 2-3 outstanding trades per year which account for 80% of their yearly excellent P&L.

To improve the odds of achieving that, I use a trailing profit target strategy:

Say you set a stop at -1 sigma and first profit target at +1.5 sigma: when you hit the first target, you do not take profits – rather, you enter a trailing strategy.

Your new profit target becomes +2.5 sigma, and your new stop becomes 0.

You hit 2.5 sigma? Great!

Extend again: +3.5 sigma target, +1.5 sigma stop. And so on and so forth.In short, here is a sensible approach to tactical macro trading:

- You want to recognize you’ll be right only about 50-55% of the times;

- To skew the odds towards 55% you want to have a data-driven macro process, quantitative tools to screen markets and a ‘’don’t be stupid’’ checklist before pulling the trigger;

- You want to follow a volatility-adjusted sizing process as explained above;

- You want to religiously respect your stop losses and have a system in place to let your profits run.

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This was it for today, thanks for reading.

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The global real-economy money printer is going to run very hot in 2026.

The more spendable money global economies print, the higher the nominal growth impulse we are going to get.

Central Banks around the world are not going to fight it.
In some cases, they are going to apply loose monetary policy even in the face of sustained money printing.

The question is: what asset classes benefit the most in this macro setup?
We’ll cover that in a second, but first an important message.

Let’s take a step back together and look at the macro big picture ahead of us:

1) Money creation in 2026 will be through the roof: fiscal from US (OBBB), Germany, Japan, Korea etc + AI Capex will contribute to money printing;

2) Central Banks around the world will not be fighting this at all – if anything, they are net loose;

3) Housing disinflation will help US core inflation sit in the 2.5-3.0% area for a while longer;

4) The setup is: nominal growth at 5%+, Central Banks neutral or loose, ongoing global money printing;

In 2025, net fiscal deficits and private sector leverage (read: money printing) around the world added $8.1 trillion (!) of new inflationary money to global economies.

If we look at 2026, more fiscal stimulus and more debt-funded AI capex will take place.
The global real-economy money printer will continue to go BRRR.

For your reference, here is our projection for the 2026 German money printing activities based on their large fiscal stimulus:

Global money printing correlates with nominal growth: the more aggressively we create new real-economy money, the more likely it is that nominal growth will pick up.

What about global Central Banks? Are they going to stay loose in the face of strong money printing?

The table below shows the Central Bank policy stance around the world - black if around neutral, red if tight, green if loose.

Take a look at the color scale: there is only one tight CB (Brazil), some neutral CBs (+/- 50 bps around neutral), and a big bunch of loose Central Banks around the world. In many cases, the loose policy stance comes from outright ignoring your inflation target.

In the US, Canada and Japan the terminal rate (‘‘2y forward rate’’) is around the neutral rate but there is nothing ‘‘neutral’’ about core inflation - which in all cases sits well above the Central Bank target.

A Central Bank applying neutral monetary policy in the face of core inflation well above their target and ongoing money printing…

…is a very loose Central Bank.

So, what happens to markets in such a macro setup?

My TMC Asset Allocation model says we will be anywhere between ‘’The Squeeze’’ and ‘’Goldilocks’’ depending on inflation: do we sit with core around 2.5-2.8% or do we surpass 3%?

In general, these top-right quadrants are very very supportive for risk assets.

If you look back at previous episodes of sustained money printing plus loose Central Banks, the 2005-2006 period looks like a decent parallel.

Back then, the global CPI rate was around 3% (blue) and Central Banks were gradually raising rates from 4 to 5% (orange) on average around the world.
Today, we have global inflation around 3% and global CB rates around 5% as well.

If anything, today’s setup seems more sustainable because the money printer is now fueled by government deficits, not private sector debt as it was in 2005-2007:

In that period EMs, value-oriented stock markets and commodities did great.

And right now, these are the 3 most under-owned asset classes in institutional portfolios:

After a decade of US/tech dominance and scarse capital flows towards value, emerging markets and commodities the world is largley underallocated towards these asset classes.

I am not long enough these assets.
Are you?

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The financial industry is full of jargon, opacity and ivory-tower attitude which prevents practicioners from scaling up their knowledge of markets fast.

When I started my research firm The Macro Compass, my main objective was education: breaking down financial concepts in plain English for you all.

I have recently stepped up that effort with my two macro courses:

• The Bond Market Course

• The Monetary Mechanics Course

Analysts and PMs from the top 10 hedge funds in the world went through it, and this is the feedback they are sharing with me:

But here is the kicker for you guys: this time, I am slashing prices down by 50% for the first 50 buyers!

Instead of paying EUR 998 for both courses, you’ll pay EUR 499 .
Buy one, get two courses!

The offer is valid for the next 48 hours, and only for the first 50 buyers.

Be quick and take advantage of this exclusive offer before it sells out.

Buy Now

Once purchased, the courses can be watched at any time and the supporting slides and material can be downloaded.

For more information on the courses, you can visit this dedicated page.

And now, to today’s macro research piece.

Nov 5^th will be a key date for markets: the Supreme Court will start hearing arguments on Trump’s IEEPA tariffs.

And while markets don’t seem particularly focused on this event, I believe it’s crucial to be prepared for it.

The pie chart above shows why the Supreme Court ruling will be crucial.

If the Supreme Court strikes down IEEPA tariffs as unconstitutional, around 55% of the US tariff income would be wiped out from the 2026 budget and US companies would be eligible for a refund for the 2025 tariffs paid under the IEEPA regime.

In numbers, we are talking about a $150-200bn annualized in tariff income lost for the US.

Now, you all know that from a strict monetary perspective US tariffs act like a tax.

Data is uncontroversial there: tariffs are being paid by US consumers and corporates (mostly corporates), which is akin to an increase in corporate tax rate that reduces companies’ margins.

If the Supreme Court undoes IEEPA tariffs, this would be the equivalent of a ~200bn fiscal stimulus:

The chart above shows the inflation-adjusted primary deficit spending in the US (read: money printing).

In 2025, the US government has injected $626 billion in the US economy – this is a much lower pace than 2023-2024. The slowdown in US primary deficit spending is mostly due to tariffs.

Revert the IEEPA tariffs, and the US will be going back to the glorious money printing days of 2024 at least.

So, what are the odds that the Supreme Court will strike down Trump’s IEEPA tariffs?

Prediction platforms suggest 60-65% odds, although volumes are quite small:

We can actually get an idea of the real market-implied odds by looking at another market: the newly set-up ‘’Tariff Refund Trade’’ that certain banks are allowing hedge funds to invest in.

According to Bloomberg:

‘’ Wall Street banks are arranging bets on President Donald Trump’s tariffs being struck down by the Supreme Court — long-shot trades that could pay off handsomely for hedge funds betting against the legality of the administration’s flagship policy.

Jefferies Financial Group Inc. and Oppenheimer & Co. are among firms brokering the deals, matching investors with companies that have paid tariffs to import goods into the US, according to people with knowledge of the matter and correspondence seen by Bloomberg News. …

In the trades, the importing companies essentially sell to investors any future rights to claim refunds on their tariff bills, which could come if the nation’s top court sides with an ongoing legal challenge to Trump’s tariffs. The companies sell at a discount to their expected refunds, meaning investors would reap the upside in a ruling favorable to them. The banks arranging the deals take a cut. …

For example, a hedge fund might pay somewhere between 20 to 40 cents for each dollar of claims they could get back in refunds, giving them an upside of several times their bet, according to the correspondence and some of the people, who asked not to be identified discussing potential terms. Most of the trades range in size from $2 million to $20 million, with few over $100 million, one of the people said.’’

It would seem like hedge funds are paying ~30% on average upfront for the trade, which would imply roughly the same probability that tariffs are deemed unconstitutional.

But companies are cashing in months in advance the US government refund that would come if IEEPA tariffs are shut down, so we need to make an adjustment for that.

This cross-check says the real market-implied odds of tariffs deemed unconstitutional are closer to the 40-45% area, while prediction platform sit around 60-65%.

Call it 50-50: a coin toss.

Now, let’s assume the Supreme Court strikes IEEPA tariffs down.

Can we say with 100% certainty that this will be akin to a ~200bn fiscal stimulus?

Not so fast.

Trump can also set tariffs under Section 232, 301 and 122.

Section 232 covers the sectorial tariffs under commerce authority, and Section 301 the ‘’fentanyl-like’’ tariffs under USTR authority – both fall under the executive (President) powers, not the Congress.

Section 122 also falls under Presidential powers, and it would allow Trump to go for global 15% tariffs for 150 days before Congress would have to approve.

I am saying this because while the Supreme Court might strike down IEEPA tariffs, the Trump administration has seven Section 232 sectoral investigations ending by January 2026 and could come up with more Section 301 or blanket Section 122 tariffs to offset the Supreme Court decision.

Nevertheless, we are going into a coin-flip decision and markets might find reasons to celebrate a Supreme Court decision to strike down IEEPA tariffs – but Trump has weapons to counter such decisions.

In general, bear in mind the following:

- The US will add $400bn in primary spending through the OBBB next year;

- Germany will kickstart a large fiscal spending program;

- The new Japanese PM Takaichi is working on an additional budget to increase fiscal spending;

- Korea, Canada, Sweden and Australia are expanding primary fiscal spending by 1% of GDP;

- Debt-funded AI capex might total $300bn next year

Regardless of the Supreme Court decision, the global money printing machine will accelerate.

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My macro models have been suggesting a bi-modal framework to approach markets for the near future: Run It Cold Now (growth < expectations, and dovish Fed) and Run It Hot Later (growth up, inflation risk premia up, but no Fed hawkishness).

My Run It Cold Now theory has been increasingly vindicated by labor market data, and markets are often busy trading what’s in front of them rather than looking through a potential reacceleration in 2026.

This is why it’s vital to figure out:

1. How early/late do we sit within the ‘’Run It Cold Now’’ period;

2. How much has the market priced in by now;

3. Consequently: is it still worth getting engaged in Run It Cold trades, or shall we look at Run It Hot Later ideas already?

As a reminder, my macro models suggest tariffs will act as a fiscal tightening mechanism until year-end.

By early 2026, the OBBB fiscal impulse will offset and Trump’s new initiatives alongside lowered Fed Funds and private money creation should propel a Run It Hot Later period.

First, some evidence that US labor demand is really weak: extrapolating benchmark revisions from April 2025 onwards, the US has been consistently shedding jobs!

To get a broader perspective on the labor market we can rely on unrevised data which incorporates demand and supply for labor: for example, unemployment rate and its important subcomponents.

The chart below shows the number of long-term (27+ weeks) unemployed Americans as a percentage of the total labor force. At 1.14%, this number is already as high as in 2002 or summer 2008 – in both cases, a recession was already visibly hitting America:

Why is US labor demand so weak?

Due to tariffs, the US is going through a slowdown of its primary fiscal impulse: the 2025 primary fiscal deficit sits almost 20 bps below last year and markedly below the 2023 pace.

Tariffs are effectively acting as a tax on US companies and consumers:

This seems to be confirmed by ‘’the best economist Druckenmiller knows’‘: the internals of the stock market.

The chart below shows (in white) the ratio between an index of the 5 largest US payroll processors companies and the equal-weight SPX, plotted against 2-year Treasury yields (in green).

If there are no new jobs, the largest payroll processors companies in the US will suffer - and indeed, their stocks are trading very weak.

This is an example of how the internals of the stock market suggest the US labor market is very weak, and that the Fed will be soon called to ease more:

The US economy is ‘‘running cold’’ now, yet stock markets are roaring and risk sentiment remains very aggressive - why?

The private sector money printer is going BRRRR, led by AI.

The chart below shows the big-tech announced capex spending as a % of their EBITDA – it’s already over 65% on average, exceeding the AT&T spending of 1998. To keep up this pace next year, companies will have to resort to debt-funded AI capex:

AI Capex mechanically adds to US GDP even before we get to talk about the ROI.

But the biggest issue with AI Capex is that it doesn’t really add jobs for the median American for now, and hence we are left with two economies: a hot AI-related economy, and a broader labor market struggling under the fiscal tightening induced by tariffs.

The stock market is not the economy, and the gigantic AI capex effort coupled with large global fiscal stimulus programs continues to support risk sentiment.

Our global real-economy money printing index is very strong.

We tracked the YTD pace of inflation-adjusted $ money creation around the world, and this year we have scored an impressive 5.77% increase in real-economy money printing around the world.

This comes after 3 weak years led by the gigantic Chinese housing deleveraging, and the YTD pace in 2025 is in line with the ‘’concerted global growth’’ pace of 2017.

The global pace and acceleration is quite robust, and its mainly driven by China which has restated its credit engines after 2-3 years of robust housing deleveraging.

Despite being crippled by tariffs (e.g. a large tax), US money creation is accelerating led by the AI-related debt-funded capex spending on data centers.

And money printing is only set to accelerate going forward.

From a fiscal standpoint, we are 100% sure that from early 2026 we will see:

- Germany adding to money creation via a large increase in primary spending;

- The US OBBB kicking in with its fiscal stimulus offsetting tariffs money destruction;

- Korea, Sweden, and many other countries kickstarting deficit spending programs

We might be looking into a scenario where the Fed cuts rates but global money printing accelerates.

If we dust off my TMC Quadrant Asset Allocation Model, that puts us in the top-right quadrant:

In short, historically the best asset allocation for such an environment involves selling IOUs and paper assets, and buying tangible risk assets.

Basically:

1. Sell USDs and bonds,

2. Buy stocks and assets linked to nominal growth

The most painful outcome for institutional investors would be an equity rotation towards EM/Value + a commodity rally.

These are very underowned asset classes, and they could rally right when standard portfolio hedges such as USD and bonds would fail to deliver.

And the Market Gods enjoy inflicting the proverbial Pain Trade every now and then…

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Thanks for reading!

‘’I compile statistics on my traders. My best trader makes money only 63 percent of the time. Most traders make money only in the 50 to 55 percent range. That means you’re going to be wrong a lot. If that’s the case, you better be sure your losses are as small as they can be, and that your winners are bigger.’’ – Steve Cohen.

This is a hard truth to accept for many macro investors: we will be right only about 50-55% of the times.

If your win rate is much higher than this, I suggest you extend the sample of trades you are analyzing or assess whether you are not trading macro but rather just selling optionality – short vol/option strategies have win rates as high as 90%+, but they wipe you out completely when you are wrong.

In the last 10 years, I scored a 52% long-term win rate on my directional macro trades. Once I realized that and given that the year-end P&L formula can be written as follows:

I knew I’d better make sure the size of my losses doesn’t get out of control.

This can be achieved in two ways: sizing trades correctly and designing a system that lets your winners run. We are going to talk about my approach to both angles in a second, but first another important remark.

To step up the win rate on macro trades from 50% to say 55% over a long period of time, you need to gain some edge over other macro investors.

What could that be?

- A data-driven approach with superior macro models

- The ability to assess the gigantic amount of cross-asset market signals via quantitative tools

- A particular edge in a niche market that you have learnt to navigate well over time

- Be less stupid than others

Macro models help a lot, but my ‘’don’t be stupid checklist’’ adds value too:

Points 1-3 keep my emotions in check and ground me to a more rational assessment of the trade.

Points 4-6 are about implementation.

A warning: short carry trades (and long options) are expensive to hold over time if nothing happens.

A reminder: in very choppy markets, you can get quickly stopped out with linear trades even if your thesis proves to be correct – consider whether the market regime favors linear or option implementations.

Don’t be stupid: check whether the trade you are about to add is not just another expression of a trade you already have on – I have seen people blow up as the 10 trades they were running were just…the same trade.

But it’s point 7 that sticks out: sizing and risk management define most of your P&L at year-end.

Here is how I approach them through a practical example. Say you think that the S&P500 will keep marching higher over the next month: how many SPYs do you buy?

You could be in the right or left 50% of that distribution: when you pull the trigger, you don’t know that. And because you don’t know that, you want to standardize your ex-ante sizing.

One effective way to standardize the sizing of each tactical trade so that they don’t excessively weigh on your year-end P&L is to do volatility-adjusted sizing: let’s go through the SPY example.

You could be in the right or left 50% of that distribution: when you pull the trigger, you don’t know that. And because you don’t know that, you want to standardize your ex-ante sizing.

One effective way to standardize the sizing of each tactical trade so that they don’t excessively weigh on your year-end P&L is to do volatility-adjusted sizing: let’s go through the SPY example.

Let’s set our stop at 1.5 standard deviations, and our defined time horizon in this example will be 1 month. For the SPY, using a 5-year lookback the typical 1.5x monthly negative sigma event would be a -7.6% decline.

You can play around with the lookback period if you want more history and/or assign different weight to more recent periods if you think today’s vol regime is more relevant (grey boxes).

If returns are normally distributed, we will be stopped out 6.7% of the times in our defined time horizon. But as returns often follow other distributions, it’s good practice to check the actual empirical probability of being stopped out against the theoretical 6.7% probability (orange boxes).

Finally, define what’s the fixed % of AuM you are willing to lose on any given macro trade.

A fictitious $1 million trading account willing to lose max $20k per trade which is bullish on SPY with a 1- month horizon would buy 571 SPY shares at $437 and be stopped out at $402 (-7.6% = 1.5x sigma event) hence losing $20k (= 2% of AuM).

Congratulations, you just applied volatility-adjusted position sizing!

What are the advantages of this approach?

1) You remain agnostic to ‘’volatility luck’’: if you size all positions the same, being right/wrong on the most volatile assets will make/break your P&L at year-end and that’s all about luck. Don’t gamble.

2) You remain agnostic to your ‘’conviction’’ level: the truth is that ex-ante you don’t know when you’ll be in the right or wrong 50%, so why would you over or under size a trade based on your ex-ante conviction levels? You shouldn’t.

3) This approach is really flexible: you can use it as a day trader or as a tactical macro investor, you can set stops looser/tighter depending on your approach etc.

The truth is that this volatility-adjusted position sizing approach helps you avoid your ex-ante biases: you’ll be right ~50% of the times and don’t get to know on which trades – so, size appropriately.

Ok so now you have a data-driven macro approach, tools to help you digest action in global markets, and a ‘’don’t be stupid checklist’’ to help you push that 50% win rate higher plus a vol-adjusted position sizing system to avoid big losses by design.

How do you actually make money?

First, you place profit targets in an asymmetric way to your stop losses.

If your stop loss is at -1 standard deviation, your profit targets should be at over 1 sigma: if you are able to preserve a 50% win rate, that will help you making more money on winners than you lose on bad trades.

Most importantly though, you must have a system in place to let your winners run: the best hedge fund traders I know only score 2-3 outstanding trades per year which account for 80% of their yearly excellent P&L.

To improve the odds of achieving that, I use a trailing profit target strategy:

Say you set a stop at -1 sigma and first profit target at +1.5 sigma: when you hit the first target, you do not take profits – rather, you enter a trailing strategy.

Your new profit target becomes +2.5 sigma, and your new stop becomes 0. You hit 2.5 sigma?Great! Extend again: +3.5 sigma target, +1.5 sigma stop. And so on and so forth.

These rare but outsized gains make the difference at year-end.

In short, here is a sensible approach to tactical macro trading:

- You want to recognize you’ll be right only about 50-55% of the times;

- To skew the odds towards 55% you want to have a data-driven macro process, quantitative tools to screen markets and a ‘’don’t be stupid’’ checklist before pulling the trigger;

- You want to follow a volatility-adjusted sizing process as explained above;

- You want to religiously respect your stop losses and have a system in place to let your profits run.

Thanks for reading! Feel free to share this piece with a colleague or friend.

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The US economy and markets might face a double negative whammy over the next 2 months: a large reduction of the fiscal impulse and the aggressive rebuild of the Treasury General Account (TGA).

A slowdown in real-economy money creation (primary deficits) could result in an economic slowdown, which will coincide with a drainage of bank reserves (TGA buildup) from markets.

Our US primary deficit tracker stands at 1.54% of GDP as per last week, already lagging behind the 2024 pace and way behind the 2023 staggering pace.

Tariffs came in at almost $30bn in July, and were this pace to continue we’d effectively face an additional $150bn of fiscal drag until the end of the year.

That alone means the US primary deficit might shrink by 15% from $1 trillion in 2024 to $850 billion in 2025:

As a reminder, primary deficit spending = money being injected in the real economy.

Literally, we are talking about money printing.

As step 1 the US government spends money (e.g. cuts taxes) which increases the bank account of households which receive an injection of net worth – they pay less taxes, hence their bank accounts are fatter. Bank deposits grow at commercial banks, which as a result see their reserves at the Fed grow too.

Step 2 describes the bond issuance pattern: the US government issues bonds to ‘’fund’’ deficits, and banks swap reserves for bonds at auctions.

This slide comes from my Monetary Mechanics course, in which I cover all the plumbing topics and variations you can ever imagine – take a look here if interested:

So the private sector will receive a smaller injection of wealth from the US government going forward.

Money creation will still happen, but at a reduced pace – but how should we think about the TGA rebuild?

When the government wants to rebuild its Treasury General Account, it issues bonds but not for the purpose of ‘’financing’’ money creation – rather simply to rebuild its coffers at the Fed (TGA).

As you can see from the T-Accounts at page 2, a TGA rebuild ends up with a reduction in bank reserves (steps 2 and 3) and no creation of money for the private sector.

TGA rebuilds are not uncommon, but as we sit at $421 billion now and the Treasury targets $850 billion by the end of September, the $400bn+ increase in 8 weeks would be one of the most aggressive TGA rebuilds over the last 10 years:

Bank reserves are currently sitting at $3.3 trillion, and given the ongoing QT and large TGA rebuild they could drop below $3 trillion soon. That would be the equivalent of less than 10% of nominal GDP:

The last time we experimented with bank reserves below 10% of nominal GDP was in 2018-2019, and this eventually led to pressures in the repo market in September 2019.

This excellent speech from Waller encapsulates how the Fed thinks about an adequate level of reserves.

A scarce level of bank reserves means US banks would be more reticent to engage in the repo market (lend reserves against Treasury collateral) and more conservative in their risk-taking.

As Waller stated in his speech: ‘’I think of ample reserves as the threshold below which banks would need to scramble to find safe, liquid funding, something that would drive up the federal funds rate and money market interest rates across the economy.’’

Also, the Fed can’t really do much to slow down the bank reserves destruction from the TGA rebuild.

Quantitative Tightening is running at $40bn/month, but $35 billion of QT is linked to mortgage-backed securities (MBS) which the Fed wants to get rid off from its balance sheet.

And the Reverse Repo (RRP) facility is only at $80 billion, so there is little left to drain there as an offset to the TGA rebuild.

If the Treasury really goes for a such a fast TGA rebuild alongside with the reduced fiscal impulse coming from tariffs, the US economy could face a soft patch right when bank reserves fall towards scarce levels leaving banks more reticent to provide repo funding and to oil the leveraged financial system.

This potential plumbing issue alongside the net fiscal drag leaves me defensive on US economic growth prospects for the next 2-3 months at least.

This was it for today. Be nimble, and remain hungry for macro.

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I

1) Elon Musk announces formation of ‘’America Party’’

2) Speaker Mike Johnson: "We're gonna have a second reconciliation package in the fall, and a third in the spring of next year..."

3) President Trump: ‘’ “Stock markets are now at all-time high -- we’re going to maintain it, believe me.”

4) Bessent: We could appoint new Fed chair in January, nominating in October

5) OMB Director Vought sends official letter to Powell saying ''Chairman Jerome Powell has grossly mismanaged the Fed''

Musk’s America Party might as well cost the Republicans both the Senate and House in the 2026 mid-terms. That’s a big political risk for Trump.

The response from the Trump administration is very clear - run the economy hot. More fiscal stimulus with reconciliation bills on the table again, and dovish pressure on the Fed.

The interference with the Fed independence is increasing by the day, with clear attempts to find ''cause'' to fire Powell (e.g. ''gross misconduct'' mentioned by Vought).

If you run the economy hot with inflation already above target and force a dovish reaction function at the Fed, our asset allocation model moves towards the ''Everything Rally'' Quadrant:

Historically, the best asset mix for this scenario is to get rid of USDs and underweight long-end bonds and buy:

1) Assets denominated in USD that produce inflation-proof cash flows;

2) PPAs: Policymaking Protest Assets

Why do these assets perform well in such a macro environment?

Trump's plan with tariffs, fiscal and lower front-end real rates means that real growth remains ok as the tariff passthrough hits consumer spending, but rounds of fiscal stimulus preserve real purchasing power for consumer and capex for companies. It holds fine.

Nominal growth is instead more robust in the 4-5% area as inflation remains sticky due to tariffs and fiscal. And you make sure that real yields remain compressed.

Basically: you run it hot.

In such an environment, specific stock markets composed of companies with strong pricing power (e.g. tech) fare very well as it happened in 2003-2006 and 2013-2019 ''Run It Hot'' experiments. But the two prior experiments were run with inflation at or below target, no tariffs, no attacks on the Fed independence, and no hostile policymaking against the rest of the world.

Today, I believe a mix of such investments and PPAs (Policymaking Protest Assets) would work better.

PPAs are assets denominated in USD that represent a release valve against unorthodox policy mix such as forcing real rates too low vis-à-vis the level of nominal GDP, manipulating long-end yields via reducing issuance or encouraging banks to buy (SLR reform), or incentivizing foreign countries to diversify away from USD investments.

Gold and metals in general are the longest-standing PPAs, and needless to say Bitcoin is also a valid contender for PPA properties:

The questions we should all be asking ourselves are:

A) How long the USD am I in my portfolio? (Probably too much)

B) Do I have enough assets producing inflation-proof cash flows? (Probably not)

C) Do I have enough PPAs in my portfolio? Gold, metals, Bitcoin? (Probably not)

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For questions/remarks/grandma pizza recipes, feel free to drop me an email at themacrocompass@gmail.com

Stay humble in markets,

Alf

Alongside with running my hedge fund, I work as a consultant and external advisor for some of the largest pension funds, asset managers, banks and funds in the world.

Arrangements are flexible: from access to my institutional research + daily access to me all the way to monthly or quarterly calls and sitting through your investment committees.

If you think I could add value to your firm, simply reach out at:

alf@themacrocompass.com

Please state your name, company, and how you think I could help.

And now, to today's macro research piece.

Let’s start this macro piece with a little game.

Below you find two tables representing 3 consecutive prints of core CPI in the US including its subcomponents: core goods and core services (with a separate mention for ‘’supercore’’ CPI).

Without using Bloomberg or Google, are you able to tell which 3-month core CPI streak belongs to the pre-pandemic period and which one to today?

I wasn’t, and some of the hedge fund PMs I asked the same question ended up making a mistake.

In both cases, core CPI MoM prints were averaging 0.15-0.20 which is broadly in line with the annual 2% inflation target and the subcomponents painted a picture of 0% goods inflation with core and super-core responsible for the quite muted inflationary pressures.

The answer: section 2 covers the Jun-Aug 2019 period, and section 1 shows Core CPI for Mar-May 2025.

I think we should take some time to reflect on this.

In early 2019, Powell pivoted dovish with a clear speech highlighting the tightening cycle was over and the Fed was all about accommodating financial conditions.

Core inflation averaged 0.2% MoM in summer (higher than today), unemployment rate was 3.7% (lower than today, and stable), and the Fed moved on to cut rates from 2.25% to 1.50% in Q3 2019.

Fast forward to today: the last 3 core inflation prints averaged 0.14% MoM with weaker services inflation, unemployment rate is steadily climbing up at 4.24%, and Fed Funds sit 200 bps above summer 2019.

The Fed might soon capitulate dovish.

Also, amidst this tariff noise it’s helpful to take a step back and remember core goods only represent ~20% of the core CPI basket.
The real action lies in services and housing (dis)inflation.

The guys at WisdomTree developed a real-time core inflation metric that uses actual housing inflation rather than the lagging shelter CPI metric:

Core CPI using real-time shelter inflation (blue) has been around 2% for 18 months already, but the lagging nature of shelter CPI (grey) pushed official core CPI higher limiting the ability for the Fed to cut.

The lagged disinflation in housing seems set to continue, which means the official core CPI measure might keep declining based on official shelter inflation dropping (it’s 35-40% of the core CPI basket: it matters).

Notice how using real-time shelter inflation works both ways.

The red circle highlights the mid-2021 period when the housing market was ultra hot but shelter inflation didn’t yet show up in the official core CPI – which tricked the Fed into mistakenly delaying the hiking cycle.

The opposite has happened in 2024, but the last 3 core CPI prints are now decisively dovish.

It’s time to follow the Fed very closely to grasp when the dovish turn might come.

The title of this piece is ‘’null komma null’’, a German expression which means 0.0 and we can say the excess inflation today compared to pre-pandemic periods is actually null komma null.

But there is another ‘’null komma null’’ which is crucial for markets and asset allocation.

A close friend, mentor and hedge fund PM recently had a chat with a German pension fund manager and asked him how much additional USD hedging they have done given the correlation break between EURUSD and risk assets.

‘’Null komma null’’. Nothing, no additional hedging has been done.

Basically, pension funds and insurance companies remain very long (and hurting) the US Dollar:

The reason is very simple: FX hedging costs are still high, and pension funds/insurance companies have return targets to meet.

Picture this: the standard return requirement for a pension fund is 6.5/7.0%, and if you are in Switzerland or Japan hedging your USDCHF and USDJPY exposure for the next 12 month costs 3.5-4.0%.

That’s quite a hefty negative carry to pay, and this deters pension funds managers from hedging.

But.

In a scenario where:

1. The Fed turns dovish and starts delivering cuts

2. USD hedging costs start to drop

3. The USD depreciates further, reminding foreign pension funds of their losing long USD position

We could see a fast acceleration in USD hedging demand from foreign whales around the world.

Such hedging activity would compound USD weakness very rapidly.

If such an outcome unravels, the market implications are pretty straightforward.

Short the denominator, long the numerator.

The US Dollar remains the denominator of most financial assets out there, and the combo of a dovish Fed turn + Trump policies + hedging activity would definitely ‘’weaken the denominator’’.

When it comes to the ‘’numerator’’ (i.e. what asset you go long vs the USD), my view is:

• FX: prefer currencies potentially involved in hedging flows (EUR, CHF, JPY, AUD, CAD etc)

• Equities: prefer sector/countries with high pricing power (tech, large cap) or commodity exporters

• Commodities: long metals (gold, silver etc)

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This was it for today, thanks for reading!

Alongside with running my hedge fund, I work as a consultant and external advisor for some of the largest pension funds, asset managers, banks and funds in the world.

Arrangements are flexible: from access to my institutional research + daily access to me all the way to monthly or quarterly calls and sitting through your investment committees.

If you think I could add value to your firm, simply reach out at:

alf@themacrocompass.com

Please state your name, company, and how you think I could help.

On Friday, the credit agency Moody’s downgraded the US rating by one notch to Aa1 (equivalent to AA+).

By now, you’ve probably read tens of opinion pieces arguing this is the beginning of the end, and that there will be dire consequences for the US Treasury market.

In this piece, you’re going to read a more sober and data-driven approach to this downgrade.

The first thing to understand is why Moody’s downgraded the US: ‘’ Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest cost’’.

The mainstream take here is that this makes sense because the US will never be able to repay its debt and because interest costs have now exceeded $1 trillion per year.

Once you understand the monetary system, both these assertions don’t make any sense:

Any government doing deficit spending and issuing bonds in its own currency (like the US) is not walking into an abyss of doom – it’s just choosing to stimulate the economy by printing money for the private sector.

It doesn’t have to repay anything – if it tries that via budget surpluses it will cause the opposite effect and end up hurting the private sector (via higher taxes).

The process of fiscal deficits creating money for the private sector is explained in the T-Account chart.

Step 1 is the government blowing a hole in its balance sheet to print money for the private sector (aka deficits), which adds net worth for households and corporates which see their net bank deposits increase. These deposits end up at banks, which in turn also see their assets (reserves) increase.

Banks will then swap these reserves for bonds at auctions where the US governments funds its deficits via issuing bonds and primary dealers (banks) plus foreign investors show up to buy bonds – step 2.

Ok fine, ‘’US debt levels are too high now’’ is a groundless worry touted by rating agencies and mainstream commentators but surely paying $1+ trillion in interest costs must be a scary proposition?

Not really: for every $ the US pays for interest on debt, there is an investor making $ on risk-free interest rates she is collecting by owning Treasury bonds.

Repeating this concept is useful to demystify the monetary system: yes, government debt and US interest payments are rising but it’s not like the US needs to ‘’choose’’ between spending on interest and spending money for healthcare – the government balance sheet doesn’t work like ours.

The real limitation to uncontrolled deficit spending is inflation and scarcity of resources (2021-2022 prime example) and not some budget constraints typical of a household.

Ok, but how does the Fitch downgrade affect investors and market participants?

The key point is that US Treasuries are now rated AA+ instead of AAA.

US Treasuries are the most widely used form of collateral in the world due to their high rating, liquidity, deep repo market and solid democratic foundations/rule of law.

Does the downgrade affect that?

Commercial banks are huge buyers of Treasuries: they use them as regulatory liquid assets (HQLA), as collateral and also sometimes as an asset to hedge interest rate risk on their liabilities.

The Basel regulatory framework introduced 10 years ago has 0% capital requirements for government bonds rated between AAA and AA- for its standardized approach: the downgrade to AA+ wouldn’t make any difference. Most banks actually choose an internal-rating based (IRB) approach based on internal models and in that case most jurisdictions apply an exception for any investment-grade rated domestic government bond which automatically assigns them a 0% risk weight.

Bottom line: for banks this downgrade makes no difference at all.

Treasuries are also widely used as collateral in repo transactions: for instance, pension funds and insurance companies lend their unsecured cash parked at a bank against collateral to upgrade the safety of their ‘’cash’’ deposits in a so-called reverse repo transaction.

A secured loan with UST as collateral (e.g. reverse repo) is safer than parking cash unsecured at a bank.

Does a downgrade affect the collateral status of US Treasuries?

The table above shows the Basel committee recommended haircuts for repo transactions.

As you can see, bonds rated between AAA and AA- fall in the same bucket (little haircut required).

The Moody’s downgrade doesn’t affect the role of US Treasuries in the financial plumbing world: banks still face 0% risk-weights when buying Treasuries, and the role of US bonds as the main collateral underlying the global repo market remains intact.

People will now try to compare the short-term bond market reaction to 2011, the last time when US Treasuries received a surprise and significant rating downgrade. Yet, the comparison makes no sense.

Remember that 10-year government bond yields can be decomposed as:

The downgrade can only directly impact the third component – term premium, which measures the compensation investors demand for various uncertainties attached to owning long-dated US Treasuries (generally growth and inflation volatility, but occasionally also other type of uncertainties).

We have shown how the downgrade doesn’t affect the role of US Treasuries in the global plumbing system, hence unless investors initiate a self-fulfilling fire-sale there shouldn’t be much impact from Moody’s action.

Yet, Moody’s is right on one thing: persistent primary deficits (3%+/year and growing) do require a different approach to bond markets than we had during the 2012-2019 period.

If you check the simple equation above, you will see that fiscal stimulus serves as a boost for cyclical growth which turns growth expectations higher – or alternatively, it limits the extent of economic weakness.

By constantly creating money for the private sector at a sustained pace, 3%+ primary deficits also contribute to stickier inflation – hence also affecting the second part of our equation.

The Fed still believes the neutral nominal rate (the rate at which the economy doesn’t cool off or overheats) sits at 3%, but it’s fair to assume that persistent fiscal deficits combined with a de-leveraged US private sector have pushed it higher. The bond market instead prices the US neutral rate at 3.50%, and it maintains a steep curve in the 10-30 year area as investor demand compensation to own long-end bonds.

Bonds are fairly priced here. I would start accumulating more 30-year Treasuries >5.25%.

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Investors love to attach an ex-post narrative to any price action, and this time the blame was on Trump’s erratic policies, the reduced attractiveness of US assets, and ‘’China dumping’’. Two of these actually make sense (you can easily guess which ones).

But there is a much bigger catalyst for the USD to sell-off more: FX hedging flows from proper ‘’whales’’.

These whales control $30 trillion (!) in USD-denominated assets, of which 13 trillion in equities and the remaining portion in fixed income instruments.
You may know these whales by their common names: GPIF, Norges Fund, CPPIB, APG, SuperAnnuation…

Foreign pension funds, insurance companies and asset managers are the true whales that could dump more US Dollars in an attempt to correct their sizeable and secular ‘’under-hedging’’ of USD risk:

In this article I will try to explain why these FX hedging flows (sell USD) could be triggered, quantify how big these flows could be, and assess which countries and currencies could represent the bulk of it.

The analytical process requires us to identify how big their USD asset pool is (in % of their domestic economy) and how much under-hedged they are.

But first – why do foreign whales actually ‘’under-hedge’’ their USD risk exposure?

Imagine you are the CPPIB – Canada’s biggest pension fund with $500bn+ in AuM.

You have to generate a consistent return of ~6-7% to be able to service your liabilities (future pensions), which means you’ll invest in a portfolio of stocks, bonds, real estate and alternatives.
Your liabilities are in CAD (as you’ll pay pensions to Canadians) but your assets can’t only be CAD-denominated because to satisfy your investment needs you’ll need to look into the US stock markets, $- denominated hedge funds, Treasuries etc. But by investing in USD-denominated assets, you are also implicitly getting exposure to USDCAD risk.

So – how much USD risk should you hedge? Or namely, how much USDCAD should you sell as a hedge?

The study above from Schroeders details the industry-standard approach: the top chart looks at the correlation between USDxxx (e.g. USDCAD) and your investment asset class (e.g. equities).

Recently, the USD has ‘’always’’ rallied when stocks sold-off as the world scrambled towards the safety of US assets backed by sound policymaking (= USD smile), and therefore being ‘’under-hedged’’ was great.

On top of it, given a currency like CAD (table below) is commodity/risk-on cyclical, during equity sell-offs having an active ‘’long’’ USDCAD exposure through under-hedging worked even better – and so the suggested USDCAD FX hedge ratio for a 60/40 portfolio is 40%.

But what happens when the USD does not rally (!) during risk-off environments, exactly as we are witnessing recently?

In that case, being under-hedged (= actively long USD) becomes painful as it compounds negatively alongside equities (and perhaps also bonds) losing value.

And that’s when these foreign whales would be forced to hedge, and kickstart a substantial USD firesale process.

Let’s dig into the data and find out:

A) How big these USD selling flows could be

B) Which currencies would be involved the most and why

The full macro research piece is available to the TMC institutional tier subscribers - a subscription costs several thousands of dollars per year.

But you don’t have to pay that - if you act now.

As we are getting a large influx of institutional demand for The Macro Compass research, we might be soon closing to subscriptions at retail-friendly prices.

This is why today I am telling you: go for it today.

The first 20 Substack TMC readers who will use the code USD20 for our All-Round tier will get 20% OFF the (already retail-friendly) subscription price.
You’ll end up paying only EUR 999/year.
That’s only ~19 EUR/week to read my institutional-grade research every week.
The offer is valid only for TODAY!

Use the link below. Be amongst the 20 who get in:

Yes, Get Me In Now

‘’There are decades where nothing happens; and there are weeks where decades happen’’ – Vladimir Lenin.

Markets were sleepwalking into April 2^nd before we had a decent sell-off in US stock markets on Friday.

But the size of the YTD sell-off (a mere 5%) masks a very interesting pattern happening below the surface.

For the first time since the first half of 2008, we are observing a rare macro pattern – almost a unicorn.

The S&P 500 and the US Dollar are going down at the same time:

The chart at page 1 shows the 3-month rolling returns for the US Dollar Index (DXY) and the S&P 500.

Historically, large SPX drawdown (left part of the scatter) tend to see the USD rallying heavily: the most convex USD appreciation (upper side of scatter) tends to coincide with bad equity drawdowns.

This also implies that the upper-left quadrant (SPX down a lot, USD up a lot) experiences the most elongated tail of all the quadrants.

The ‘’Macro Unicorn’’ bottom-left quadrant with SPX drawdowns happening alongside a weak USD is not very populated. It’s crucial to remember the last Macro Unicorn dot goes back to July 2008.

Why was it so hard for the USD to weaken while the S&P 500 was going down?

This is because of three reasons:

1) After 2008, the Eurodollar system blew up in size and never looked back;

2) The US aggressively swallowed global trade surpluses, and in exchange became the epicenter of all global financial flows into Treasuries and US stock markets;

3) Policymakers applied growth-friendly disinflationary policies and politicians postured towards defending Pax Americana on the geopolitical front

With such a combination of factors, the USD tends to appreciate during risk-off events.

A portion of the 12+ trillion dollars of USD debt issued by foreign entities has to be refinanced in any given year, and a risk-off environment which threatens to slow down global trade means all foreign entities rush to buy USDs to service their debt.

Foreign investors buy Treasuries because the Fed has your back and it will cut rates if financial conditions materially worsen – cross-border buying of US Treasuries strengthens the USD as money flows in the US.

The same foreign investors are reluctant to wind down their US equity exposures because Fed cuts will ultimately restore confidence.

Net-net, the USD goes up in risk-off events.

The only periods when the USD weakened alongside the SPX were 1998, 2002 and H1 2008.

These are all periods where US bubbles ended up deflating rapidly: think of the Dot Com bubble burst in 2001 or the US housing market crash of H1 2008 – before it turned into a global financial crisis.

These episodes all have one thing in common: a US idiosyncratic crisis.

And today, US policymakers seem to be doing all they can to generate one.

On the macro front, the US administration is injecting a large amount of uncertainty.

The ‘’no-visibility’’ approach from Trump on tariffs brings big unpredictability – and it’s also nearly impossible for US companies to plan capital expenditures and hiring given there is no visibility on tariffs.

To that business uncertainty, you need to sum up the leaked White House memo to the Washington Post (here) which aligns with the recent Musk interview highlighting a 25-35% cut to the federal workforce to achieve budget savings close to $1 trillion/year by the end of May.

Former Linkedin Chief Economist Guy Berger looks at a variety of high-frequency leading job market indicators, and I respect him as a non-biased non-alarmist economist.

He just produced the chart you see below:

Quoting him: ‘’The diffusion index of future headcount plans is now worse than it was immediately prior to the election. Additionally, and concerningly, that pessimism about the future is also affecting the present: the diffusion index of recent employment actions is trailing a year earlier by more than pre-election.’’

And this is before the Trump administration starts slashing ~800k federal employees.

To add to the potential ‘’Macro Unicorn’’ move which stems from a US idiosyncratic crisis, we are witnessing the very first signs of the unwind of the gigantic long US equity position held by foreign investors.

As shown by my friend Brent Donnelly, it is very rare to experience a month when the DAX is up while the SPX down – and we just experienced it:

If you take a step back, you realize that foreign investors have accumulated a gigantic amount of US securities since 2010. Trade surpluses came with a USD surplus for countries like Germany or Norway, which then recycled these excess USDs back into US Treasuries and US stock markets.

Canadian and Swiss investors own US securities to the tune of 100%+ of their GDP:

What if some of these foreign whales decide to reduce their exposure to US assets?

It would make sense given the new US geopolitical stance, the non-supportive policy mix (non-proactive Fed and tighter fiscal stance), business uncertainty from tariffs and still elevated valuations.

And what if markets get caught by surprise by a sudden change in correlations?

Exactly like in early 2022 when the correlation between bonds and stocks turned positive after 10+ years of persistently negative correlation as the Fed embarked in a hiking cycle that also hurt stock markets.

The Trump administration is trying to achieve an arduous trifecta: a weaker USD, lower yields, and a robust stock market.

Historically, to achieve this rare trifecta you need very disinflationary policies (yields and USD down) and a supportive Central Bank that boosts stock market sentiment.

The current policy mix of geopolitical shifts, tariffs and macro uncertainty risks achieving a weaker USD and lower yields but at the expense of the economy and the stock market.

After 17+ years of absence, the Macro Unicorn of simultaneously weak USD and weak US stock markets could stage an unexpected comeback.

Long-term macro investors should reduce their (implicit or explicit) exposure to the USD which has historically served well as a hedge against stock market drawdowns – if the Macro Unicorn appears again, a long USD long stock position could hurt twice.

If you are a hedge fund or a more active institutional investor, there are very interesting derivatives trades that can be structured to take advantage of the Macro Unicorn – text me (Alfonso Peccatiello) on Bloomberg and I’ll be happy to discuss.

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Before we go into today’s piece, a short announcement.

I advise several institutional investors on a bespoke basis.
Clients include Canadian pension funds, one of the biggest tech companies around, and top 3 multimanager hedge funds in the world.

Services go from sitting on the investment committee as an independent advisor, to constructing specific macro portfolios/hedging programs and consulting on a day-to-day basis (i.e. act as their independent macro analyst).

Are you are interested in my macro advisory services?
Please shoot an email with your request at: alf@themacrocompass.com

Fair warning: it’s not cheap, and it’s only for institutional investors.

Now, to the piece.

The first 5 weeks of the year have seen international equities outperforming the S&P 500: European and Chinese stocks have rallied harder than US stock indexes, and certain emerging markets like Chile or Poland are doing even better.

My main thesis for the first half of the year remains to be positioned with an ‘’International Risk Parity’’ portfolio: long US bonds, and long stocks around the world.

Let’s take a look at why.

The chart above shows that the US growth exceptionalism might be over.

The Aggregate Income Growth series is a great proxy for nominal growth in real time: it includes private sector job creation, workweek hours, and wage growth – effectively reflecting the growth rate of nominal income US workers are bringing home.

Today, it sits at 4.5% which is exactly the average level it recorded in 2014-2019.

These are the Goldilocks growth conditions and controlled inflation that international stocks enjoy.

Let’s now perform a data-driven analysis of what asset classes perform best during this prevailing macro conditions, and specifically when:

• Core inflation is in the 1.75-2.25% range;

• Real growth is in the ~1.50-2.50% range.

Here is what we found:

On a risk-adjusted basis, bonds do well - especially the long-end.

Stocks perform well too, with international stocks performing slightly better than US stocks: in our sample, European stocks pop up very often with CEE countries (higher beta like Romania or Hungary) leading the table.

To do well, international stocks need a combination of:

• Goldilocks growth conditions (no US exceptionalism);

• (On the way to be) controlled inflation and predictable Central Banks;

• Reasonable valuations and a new narrative replacing the existing stale one.

Which brings us to the other required conditions: friendly developments in inflation coupled with a reasonable Central Bank, cheap valuations and a new narrative prevailing.

What are the best countries to look at today?
Let’s have a quick look at valuations:

The table above shows the forward P/E ratio for various international equity markets, and the most right column shows the 10-year percentile of valuations.

Broader European equities are still reasonably valued (Stoxx 600 more than Stoxx 50 which tends to give more focus to large cap German and French companies), but the standout country remains Poland.
Outside Europe, several countries in Asia and LatAm show cheap valuations.

Price-to-earnings ratios alone are not enough as a metric for valuations, and to broaden up the valuation assessment I like to look at Free Cash Flow Yield too.

FCF yield is the ratio between free cash flows and enterprise value, and you can think of it a measure of the amount of net cash genetated by the company and literally available to stock investors divided by the enterprise value.

The table below shows the 10-year percentile of FCF yield for different US and EU sectors, and different stock indexes around the world - the lowest the percentile, the cheaper the valuation:

If you consider valuations, policymaking and narratives my shortlist for international equity markets includes:

• Developed markets: Europe, Japan, and Canada

• Emerging markets: China and Mexico

Europe, Canada and Mexico were ‘‘priced to die’’ under the tariff threat, but as time goes by without much being done there investors are slowly realizing that inflation is under control and Central Banks are acting dovish. That supports stock markets.

In Japan, valuations are still broadly attractive because investors are growing nervous on how hawkish the BoJ will be - yet nominal growth is doing great (~5%+) and Ueda already verbally intervened to put a cap on bond yields.
Strong nominal growth and a cap on excessive tightening will benefit Japanese stocks.

Despite the big rally, Chinese stocks are still reasonably priced - the PBOC remains ready to ease, some fiscal spending is happening, and investors are largely underallocated.

In short: our analysis suggests that an ‘‘International Risk Parity’’ portfolio built with long US bonds and long international equity markets will perform well in H1 2025.

Thanks for reading!
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Before you go, don’t forget this.

I advise several institutional investors on a bespoke basis.
Clients include Canadian pension funds, one of the biggest tech companies around, and top 3 multimanager hedge funds in the world.

Services go from sitting on the investment committee as an independent advisor, to constructing specific macro portfolios/hedging programs and consulting on a day-to-day basis (i.e. act as their independent macro analyst).

If you are interested in my macro advisory services, please shoot an email with your request at alf@themacrocompass.com

Fair warning: it’s not cheap, and it’s only for institutional investors.

And now, to the piece.

Our main macro thesis for the first half of 2025 is that another disinflationary wave will hit the US.

We expect core PCE to annualize at or below 2% in H1 2025.

Our Leading Inflation Indicator suggests we might be due for one last wave of disinflation in the first half of 2025:

To add some substance, this Leading Inflation Indicator is built using the 7 most statistically significant forward looking indicators for core US inflation.

The most recent dip is mostly attributable to leading indicators of shelter inflation, which represents 30%+ of the core US inflation baskets.

As you know, official shelter inflation tends to incorporate on-the-ground rent growth with a delay due to its methodology and series like the Zillow Rent Index have been used to predict where shelter inflation will go.

The CoreLogic single family rent index is one of the best predictor of shelter inflation, and it just printed at the lowest level in 14 years:

Some weakness in the housing market is starting to emerge - as evidenced by other leading indicators as well.

One of the main reasons why the housing market held up so well despite high mortgage rates was the gigantic backlog to work through.

During the pandemic, the demand for housing was super hot but supply bottlenecks and labor shortages lengthened the housing construction cycle - and this led to large backlogs which kept the housing market afloat.

Big US homebuilders like D.R. Horton are now reporting their backlogs have returned to 2019 levels, so this tailwind seems exhausted:

Additionally, yesterday's JOLTS report shows that the job openings for the construction sector are shrinking fast (see chart below).

The construction sector is key to the US business cycle, and cyclical weakening there has always been an early signal of a broader softening in US growth conditions.

Just to be clear: construction workers aren't getting laid off yet.

But it seems that the conditions are in place for a slowdown in the housing sector, which also leads to disinflation through the rent of shelter component:

Incoming data on inflation, growth and the housing market suggest a disinflationary slowdown in growth could be ahead of us. In that case, the Fed could quickly switch to a quarterly pace of cuts and reassert the Fed Put.

This ‘’proactive risk management’’ dovish stance would ease financial conditions = stocks and bonds rally:

Looking at the relative valuations across stocks and bond markets, the best risk/reward lies in fixed income.

At the moment, this is what the market is pricing the Fed to do over the next 2 years:

The Fed is priced to be on hold in March, deliver maybe 2 cuts in total this year, and pretty much stop there.

The terminal rate is priced around 3.90% - and that’s where the Fed cutting cycle stops.

Given the odds of Fed hikes are relatively small as long as Powell remains Fed Chair until May 2026, bonds offer an interesting risk/reward if my disinflationary thesis proves correct.

This was it for today, thanks for reading.
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In this piece I will highlight the rationale behind my base case scenario and its impact on markets.

Before we do that, I want to share something with you.

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And now, back to the article.

1. Recent economic data provides Trump with cover to go big on tariffs

The biggest risk Trump runs with tariffs is a bond market insurrection: if investors perceive inflation as too high, tariffs can generate an injection of risk premium that launches bond yields to the moon.

In turn this would tighten financial conditions, slow down the economy, hamper Trump’s plans to reduce borrowing costs for the US, and just make him quite unpopular (people hate inflation spikes).

Luckily for him, the recently released inflation report suggests core PCE is trending at 2.3% - not bad:

Additionally, the latest job market report was encouraging and the control group of retail sales is running at 5.4% - around 2018 levels, when the pre-pandemic economy was considered strong. The economic momentum and a 2.3% trend in core PCE inflation provide Trump cover to go big on tariffs.

2. To increase his negotiating power, Trump can target vulnerable economies

As the Fed hiked rates, all other Central Banks around the world merely followed the same strategy. The big issue here is that not all economies were equipped to handle such an abrupt increase in rates.

After the GFC, the US economy has deleveraged its private sector – private debt to GDP is down in the US. The US private sector also borrows mostly on fixed rate for long tenors (think about 30-year mortgages). The US also issues bonds in the global reserve currency, so bond vigilantes are unlikely to go after the US.

But what if another economy had high private sector debt, or upcoming refinancings, or floating rate mortgages and corporate borrowing which makes the passthrough of rate hikes fast and furious?

In that case, the economy will prove quite vulnerable to a prolonged hiking cycle.

The BIS just updated their private sector Debt Service Ratio (DSR) for H2 2024 – this snapshot allows us to verify in which countries households and corporates are under pressure from a prolonged hiking cycle.

Red or green colors refer to how much the DSR is above or below its long-term average in that country:

Notice how Canada and China are under increasing pressure.

And it would make sense for Trump to go after them – negotiating with a weak counterpart is always better. But identifying vulnerable economies is not only about the Debt Service Ratio – politics also matters.

For example, Germany is very unlevered as an economy: the German DNA prevents (for now) any proper deficit spending, and the private sector is also relatively conservative on how much it leverages.

As a consequence, the DSR doesn’t really pick up – yet the German economy is vulnerable.

Its business model of cheap energy imports and outsourcing production and manufacturing has been challenged by the pandemic, and China has made huge progress as a competitor for car exports. The German economy has taken a major hit, and people aren’t happy.

New elections are planned for February, and negotiating with a country in political turmoil is always better. From a game theory perspective Trump could decide to focus on China, Canada and Germany.

3. A tariff strategy to raise the most amount of money, and take the smallest amount of risks

Even if Trump wants to target the most vulnerable economies, he must be careful.

Let’s take a look at the countries the US imports the most from, and in which categories of imports:

The car, pharma, oil and household/tech goods industries are by far the largest import sectors for the US. And Mexico, China, Canada and Germany the top 4 countries that exports the most volume to the US.

If Trump’s intention is to raise the most amount of money through tariffs on the most vulnerable economies, basic logic imposes equally heavy tariffs on all these 4 countries above.

But there is a risk in going huge against China from the get-go. While it’s very unlikely that Canada and Europe will protect their currencies, China could decide to do it.

And if we get 25%+ tariffs on China from the get-go but the CNY doesn’t weaken, US consumers will feel it. Higher import prices on Chinese goods without an offsetting move up in USDCNY = US consumers will take the hit out of Chinese tariffs, and not China.

Here, game theory would hence suggest Canada and Europe are the prime candidates for heavy tariffs.

Conclusions and market implications

Given that:

1) Soft inflation and solid growth provide cover for Trump to go aggressive on tariffs

2) To increase his negotiating power, Trump might focus on the most vulnerable economies

3) China, Canada and Europe are 3 vulnerable economies and the all export a ton to the US

4) But China can hit back via supporting the CNY = US consumers would pay for tariffs

5) Canada and Europe are not in a position to defend their FX, and they face political jitters

My base case for tariffs sees:

• A global tariff rate of 10%

• Additional targeted tariffs on China (phased-in monthly increase of 2.5% with no end in sight)

• Additional targeted tariffs on Europe and Canada for a total of 25% to start (+ monthly increases)

If this unfolds, the market is not prepared.
Over the following 2-4 weeks, I would expect:

A) EURUSD to breach parity, and USDCAD to march towards 1.50

B) Bonds to rally at first, and stabilize after

C) An initial knee-jerk negative reaction in stock markets

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Speak soon and have a wonderful day,

Alf

In this macro piece, we will cover the biggest market mover for H1 2025: tariffs.
We will also investigate what’s the most attractive asset class today.

But before we start, here is a present for you to kickstart this new year.

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Now, to the piece.

What if tariffs end up being non-inflationary and negative for growth?
And what if Trump focuses on short-term painful policies first in H1, to then deliver tax cuts in H2?
Consensus isn’t ready for this.

Let’s disentangle the thought process behind the concept of ‘’disinflationary tariffs’’.
This paper from the new Council of Economic Advisor (CEA) Chair Steve Miran covers it – I’ll summarize.

The main idea is very simple.

In his previous term, the Trump administration increased the effective tariff rate on Chinese imports by 18%.
During the same time span, the US Dollar appreciated by 14% against the Chinese currency.
It basically means the after-tariff price in USD to import Chinese goods was almost unchanged.

As long as the USD appreciates, US consumers aren’t going to feel much inflationary pain from tariffs:

Yet we also know that tariffs are negative for business sentiment, investment, and growth.

Even if tariffs are phased in gradually as a negotiation tactic, the message will be clear: if you want to export your stuff in the US, you need to re-think your business model or cut your profits.

Additionally, it’s well documented that a super strong US Dollar acts as a drag for earnings growth in the US:

US companies generate about 60% of their revenues outside the US, and a strong USD doesn’t help there.
The charts above prove that was indeed the case in 1996-2001 and 2021-2023: a relentless USD appreciation (orange line down) slowly but surely weakened earnings growth (blue) for US companies.

Under the assumption that countries hit by US tariffs will accept a currency devaluation without a fight, there are reasons to believe that tariffs can be non-inflationary and negative for growth.

But can we safely assume China isn’t going to push back?
Why would China not try to stabilize their currency and export some inflation and pain in the US?

Let’s try to think this out as if we were Chinese policymakers.
We have three options:

1) Accept the hit: let the CNY weaken
2) Fight back: protect the CNY by selling down USD FX reserves, and hit back the US
3) Play the long game

I believe China will opt for 3: play the long game. And here is what I mean.

Chinese policymakers don’t face elections, but the Trump administration does – US midterms in 2026.
Rather than going for the extremes (1 or 2), China could decide to apply a long-term strategy that relies on two pillars.

A) Allow a steady CNY deval, and plug the hole with fiscal stimulus where needed

As China can afford to play the long-game from a political standpoint, they could opt for a middle ground between a full CNY devaluation and a strenuous defense of their currency by selling USD reserves.

B) Keep using ‘’middlemen’’ to dodge tariffs

We had some fun testing this hypothesis: can we show that China used ‘’friendly neighbors’’ to re-route their goods into the US as a way to circumvent tariffs?

Since the first round of Trump tariffs went live in 2018, China (and Hong Kong) now import a volume of goods in the US which is 5% lower than the pre-tariff era.
But at the same time, Vietnam + Korea + Thailand + Malaysia have all increased their trade flow with the US.

Coincidence?
Or China trying to dodge some tariffs by re-routing their goods exports to the US through ‘’middlemen’’?

Consensus is strongly positioned for tariffs to be:

• A big macro event

• Negative only for the rest of the world (US growth exceptionalism to continue)

• Adding to inflation uncertainty in the US

I think there is space for consensus to be caught offside on all the above.

I could foresee a world where Trump phases in tariffs, China dodges most of them through middlemen countries, the anticipated inflation volatility doesn’t realize, but growth slows down because business investments are hit by uncertainty.

Given today’s pricing, the most attractive asset class in this scenario would be bonds.

Our models show that the option-implied probability for the Fed to hike (!) over the next 12 months is priced at 40%. That’s quite high, and it show the extent of hawkish pricing people pushed into the front-end of bond markets.

And not only that: the curve has bear steepened, and term premium has been injected in the long end too.

With Fed Funds at 4.25%, the bar being very high for the Fed to hike rather than cut, and 10-year yields at 4.60% (= positive carry) bonds look interesting here.

Especially if you think a strong USD will slow down corporate earnings, and that the hype about the macro impact of tariffs might be exaggerated.

This was it for today.
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Rates were mostly stuck around 0% at the front-end, and to make money you had to find small dislocations and monetize them with leverage hoping volatility would remain low forever.

Today, the story is different: bond markets are truly exciting.
So let’s have a fresh look at them.

Before we do that though - an important announcement.

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I expect the Fed to cut rates again in December.

Why?
See the chart below:

Even after the recent Fed cuts, today’s Fed Funds (orange) are still markedly above the underlying trend of core PCE inflation (blue).
The Fed is a simple animal: their dream is to have a stable labor market with predictable inflation.

And today, the main risk they see isn’t an inflation pick-up.
Instead, risk management forces them to protect the US economy against a deterioration in the job market.

Running a real Fed Fund rate (bottom chart, black) at +2% for several quarters on end is an exercise which was last performed in 2007.
I don’t think the Fed sees major benefits in running such a tight policy.

Hence, I believe they will cut rates by 25 bps in December.

But here is an argument for them to feel confident the US doesn’t need a major cutting cycle in 2025:

This chart looks at the US private sector (orange) and government (blue) debt to GDP since the 1990s.
It’s an incredibly important chart to approach US bond markets today.

The US went through two clear macro phases before today.

In phase 1 (before GFC), the US government refused to lever up: government debt as a % of GDP was at or below 60% and deficits were seen as a bad thing.
As the private sector didn’t receive any stimulus from government deficits and it grappled with declining demographics and productivity, it used leverage to achieve higher growth.

In phase 1, the US private sector was forced to lever up aggressively.
Until in 2008 excessive private debt and loose credit standards led to the Great Financial Crisis.

This kickstarted phase 2 of the long US macro cycle – the post GFC period.

Between 2009 and 2012 the US government printed money (read: deficits) to stabilize the US economy.
This allowed the US private sector to de-leverage: private sector debt as a % of GDP fell below 150%.

But this fiscal profligacy didn’t last for long: between 2014 and 2019 the US primary deficit as a % of GDP was less than -2% on average – mildly supportive for the private sector, but nothing special.
So we sat there in this limbo of acceptable GDP growth, but as neither the US government nor the private sector levered up aggressively we lived through a ‘’meh’’ US growth cycle.

Finally, C-19 hit and the game might have changed for good (phase 3).

Since 2020, US deficits have exploded and this has allowed the US private sector to de-leverage.
US private debt as a % of GDP is now the lowest since 2003 (!).

So: why does this matter for bond markets?

Because in a world with less private sector leverage, ceteris paribus interest rates can be a bit higher.

When there are less mortgages and corporate loans to refinance vis-à-vis higher nominal wages and earnings, the equilibrium interest rates at which the economy can function should be higher.
The flipside is obviously that an increasing load of government debt will have to be refinanced at higher rates.
In the US case though, that’s more manageable than for other countries due to the reserve currency status.

This is why the market feels quite strongly about terminal rates being well above 3% this time.

As per today, markets expect Fed Funds to still be at 3.50% in 3 years from now.

The most important implication for investors is this.

If the Fed embraces this new narrative, we are looking at few (if any) cuts left in 2025.
This is because if neutral rates are considered to be higher, the Fed doesn’t need to cut rates much more to achieve a neutral policy stance.

With euphoric expectations about earnings growth, nosebleed valuations and a less friendly Fed overly bullish investors might be disappointed in early 2025.

This was it for today. I hope you enjoyed this macro piece.
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Given the large influx of paid subscribers at the previous round, we are extending our big discount also to our cheapest tier - The Long Term Investor.

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Now, to the piece.

Trump is back slashing (or should we say: threatening) tariffs left, right and center.
The more gradual approach suggested by his inner circle is nowhere to be seen.
It seems like this Trump presidency will bring more volatility than the previous one.

And if you think about it, it actually makes sense.

Controlling the House and the Senate, Trump is empowered to run his last and more aggressive agenda: in Musk’s words ‘’it’s now or never’’ for implementing policies.
I feel like Trump has little to lose here, and he is calling the shots.

When it comes to markets, I believe it’s good practice to look at what happened in 2016.
The world isn’t the same, but Trump’s policies seem to move broadly in the same direction and even if history doesn’t repeat it often rhymes:

The chart at page 1 shows the Sharpe Ratio for the top 7 risk-adjusted trades in the 45 days subsequent to Trump’s surprise win in 2016.

We chose risk-adjusted returns over absolute returns to avoid giving an advantage to highly volatile assets like Bitcoin – in absolute return terms, the most volatile asset will always prevail given favorable conditions.

The 7 trades all make sense from a macro standpoint.

Stock markets and in particular small-caps and banks benefit from Trump’s economic and de-regulation agenda; yields move up as nominal growth is seen increasing; the USD strengthens against low yielders and countries hit by tariffs and Bitcoin acts as the perfect de-regulation friendly, animal spirit asset class.

Let’s now look at today.

We overlapped the 2024 performance with the 2016 performance for the top 7 ‘’Trump trades’’.

In choosing the ‘’day 0’’ for 2024 we opted for the day when the Republican sweep odds moved above 50% on Polymarket: at that point, a Red Wave was already priced as base case similar to November 9^th 2016 when it was clear Trump had won.

Here is how the ‘’Top Trump Trades’’ look priced today:

Here are 3 observations from my side:

1) Trump Trades in the stock market are experiencing a milder rally than in 2016;

2) The FX market seems unimpressed too;

3) Bitcoin has front-loaded all the 2016 gains in less than half the time.

Every time there seems to be an obvious trade we should always ask ourselves why should it be so easy.

In this case: can we safely assume there is a lot of juice left in USDMXN or stocks?Has Bitcoin already run its course?

For the Trump Trades in the stock market, one reason why we are lagging behind could be valuations.
The S&P500 wasn’t nearly so expensive in late 2016 from a forward P/E perspective, and therefore a long stock position here relies heavily on earnings to deliver as valuations are already high.

In FX, I can explain USDJPY – the Ministry of Finance in Japan limits the upside there.
But why would USDMXN not trade much higher as it did in 2016?

It seems FX markets are leaning towards tariffs being used as a negotiating mechanism rather than actual sizable tariffs being imposed on several countries in the end.

I think FX markets are largely underestimating Trump 2.0 and the volatility he will bring.

But also remember that in the medium term, macro conditions >>> reaction to short-term political agendas:

The chart above broadens the perspective on Trump Trades and it looks at 180 trading days after a Trump victory became clear in 2016 and 2024.

Notice how:

- US banks and small caps almost flat-lined after the initial enthusiasm, while the S&P500 kept going

- A short 10-year bond position lost money after the initial burst

- USDMXN longs ended up losing (!) money after 180 trading days

- Bitcoin kept going vertical and the punchiest part of the rally only happened much later

In 2017, global economies exhibited a miraculous concerted global growth amidst disinflation.
When it comes to 2025, I am not so sure that should be the base case.

I think Trump 2.0 is very much focused on foreign policy, and that this time around tariffs will become an important macro theme that stays with us for a long time.
If I am right, Trump 2.0 might sacrifice some short-term growth in exchange for harsher tariffs to pressure foreign economies to ‘’rebalance’’.

The outcome would be an increase in short-term inflation expectation but coupled with weaker growth, and a Fed likely to ‘’look through’’ the inflationary threat from tariffs to protect the US economy.

If that unfolds: most financial assets suffer, bonds do ok, the USD acts as a hedge.

This was it for today, thanks for reading.
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It’s almost been 3 years together now - and I loved every little bit of it.
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As I run two businesses now (my hedge fund Palinuro Capital and The Macro Compass), I need to focus on my customers even more.

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Now, to the piece.

The Bond Market is saying “This Time is Different”.

The Term Premium is on the rise, and it now sits close to the highest level for the last 10 years.

But What is Term Premium?

An investor looking to get fixed income exposure can do that via buying 3-month T-Bills and rolling them each time they mature for the next 10 years.
Alternatively, it can decide to purchase 10-year Treasuries today.

What's the difference?
Interest rate risk!

Buying a 10-year bond today rather than rolling T-Bills for the next 10 years exposes investors to risks – term premium compensates for this risk.
The lower the uncertainty about growth and inflation down the road, the lower the term premium and vice versa.

Uncertainty is the key word here!
The higher the uncertainty about future growth and inflation, the higher the term premium.

The left chart below shows how term premium (y-axis) increases with a higher dispersion of forecast (read: uncertainty) for inflation (x-axis):

Today the estimates of the US Term Premium have moved higher and they are now testing the upper side of recent ranges: in other words, there is some more uncertainty being priced in about the path ahead for growth and inflation.

Investors are less confident about a future of predictably contained inflation and growth, and they expect some more volatility and uncertainty down the road.

As we approach US elections, bond markets are telling us - yes, “this time is different”.
Persistent fiscal deficits regardless of who wins US elections can lead to more volatile inflation backdrops, and to more boom/bust cycles.

But as Term Premium is on the rise, should we fear the return of Bond Vigilantes?
Not so fast.

This week, Bond Vigilantes are in action in the UK: the fiscal budget unveiled by the new UK government has been assessed as ‘‘too loose’’, and therefore investors are going after all UK assets - they are selling GBP, selling UK bonds, and even stocks.

Bond Vigilantes are truly in action when they initiate a sell-off in bond markets to impart discipline to policymakers, and they hence generate a spill-over effect to the currency and potentially stock markets too.

But the US is not the UK.

Over the last 40 years, Bond Vigilantes have NEVER been in action in the US:

Over the last 40 years, we never really had investors puking on US assets - true Vigilantes are in action when both bond yields go up, and the USD goes down.
As you can see from the chart, that quadrant is basically empty.

We are instead experiencing people pushing US yields higher and the USD getting stronger. The bond market is hence sending a different message.

''Trump's policies will be stimulative for nominal growth, and the US will grow faster than other countries''.

Additionally, investors are hedging for a scenario in which rates move up fast via options. This is evident in the so-called ''skew'':

This means investors are willing to pay more for bond puts than for bond calls for the next month.

This is unusual: investors normally pay more for ''insurance premium'' (bond calls) than for puts, so this is related to election hedging.

There are no ''Bond Vigilantes'' in action here.
Instead, the bond market is preparing for a Trump victory and for policies that will be stimulative for growth and inflation.

Yet, history shows us this.

Elections are a powerful short-term volatility event.
But macroeconomic cycles tend to prevail over time.

Trump was the President in 2019 as well, but as the global macroeconomic cycle was weak 10-year Treasury yields traded as low as 2%.

If Trump secures a sweep, I expect the bond sell-off to accelerate.
Your mother and your dog will tell you to sell bonds at 4.50% yields.
That’s when you should consider buying them instead.

And don’t forget: today you should go for it.

The first 50 TMC readers who will use the code BLACKFRIDAY for our All-Round tier (multiple research pieces per week) will get 40% OFF forever.
You’ll end up paying only EUR 749/year.
That’s ~60 bucks a month to read my macro insights almost every day.
The offer is valid only for 3 days.

Use the link below. Be amongst the 50 who get in:

Claim Your Spot

Enjoy your weekend,

Alf