by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets are closely analyzing the latest CPI inflation data as they assess the Federal Reserve’s next steps. In sports, more than 100 Olympic athletes from the Paris games have returned their medals due to unexpected deterioration. Today’s Comment will explore Trump’s proposal to establish a new agency to monitor tariff revenue, the potential impact of new export curbs on chipmakers, and other significant developments. As always, we’ll conclude with a summary of key international and domestic data releases.

External Revenue Service: President-elect Donald Trump announced plans to establish a new government agency dedicated to collecting revenue from import tariffs and taxes on foreign services on his first day in office. This move will likely solidify fears that the incoming president intends to implement wide-scale tariffs, a policy that has made both bond and equity investors wary.

• While US Customs and Border Protection traditionally handles the collection of foreign duties and tariffs, the creation of this new office signals the president’s intention to leverage tariffs as a significant revenue source. This move is likely aimed at reassuring the public that his proposed tax cuts will not substantially increase the national budget deficit.
• His reliance on tariff revenue to address the deficit comes as his administration seeks to deliver on key promises to extend the Trump tax cuts, raise the SALT deduction cap from $10,000 to $20,000, lower corporate tax rates, and, if possible, implement additional tax cuts aimed at benefiting working-class households.

• Trump intends to impose a blanket tariff of 10 to 20% on all imports, with additional tariffs of 60 to 100% on goods originating from China. This would significantly increase the average tariff rate to its highest level in nearly six decades.
• Tariffs were a primary source of US government revenue in the 1800s, a time when the government was significantly smaller. Today, taxes on international trade contribute just 1.7% of government revenue, down from a recent peak of 2.1% over the past decade but well short of what would be needed to fund government spending. As a result, the president must either cut spending or rely on Americans continuing to purchase imported goods despite the tariffs.
• While we anticipate the president may impose tariffs, we are skeptical they will be as extensively applied as the market expects. Trump may need to scale back some of his proposals to make them more budget-friendly to increase their chances of becoming law.

Chipmakers Under Pressure: President Biden is expected to release new regulations aimed at preventing chipmakers from selling advanced chips to China. These moves are likely to further complicate the operating environment for semiconductor firms as they strive to maintain strong earnings amidst a growingly complex economic and geopolitical landscape.

• The new rules will place restrictions on all chips with a node size of 16 nanometers or smaller under a global regulatory framework. Those that meet the criteria will need an export license to sell to China and other countries deemed as posing a national security threat.
• The regulations will include provisions for companies to challenge these restrictions. This may involve demonstrating that their chip designs comply with the established criteria for permissible sales or providing evidence that their chips contain fewer than 30 billion transistors and are packaged by a trusted manufacturer.

• The companies targeted by the restrictions, Taiwan Semiconductor Manufacturing Co. (TSMC), Samsung Electronics, and Intel Corp., will likely be negatively impacted by the order. Intel receives nearly 27% of its revenue from China, while Samsung derives nearly a fifth of its chip revenue from the region. Ironically, TSMC has the lowest exposure of the three at 12.5%.
• Despite a robust 2024 with nearly 30% growth, the semiconductor sector has failed to surpass its July peak, indicating a potential slowdown. This weakness stems from growing concerns about a global economic recession, the looming threat of a global trade war, and the tightening of chip export restrictions. Consequently, the future performance of this sector hinges heavily on the policy decisions of the incoming administration.

Argentine Inflation: President Javier Milei intends to decelerate the monthly devaluation rate of the Argentine peso (ARS). He has implemented stringent currency and capital controls as a strategy to mitigate rapid currency depreciation and, consequently, curb inflationary pressures.

• Milei’s unorthodox approach has effectively reduced month-over-month inflation from a peak of 26% in December 2023 to 2.7% twelve months later. This significant progress is likely to encourage investors to take another look at the country as it appears to be on the path to economic sustainability.
• A crucial next step for the country will be for the central bank to rebuild its foreign currency reserves. This will serve as a key indicator of the long-term effectiveness of the implemented policies.

President In Custody: South Korean President Yoon Suk Yeol was arrested on Tuesday after repeatedly refusing to cooperate with an investigation into his decision to impose martial law last month. His arrest has eased concerns, as the peaceful nature of his detainment has alleviated fears of an escalating constitutional crisis. In response, the Korean won (KRW) strengthened by 0.2% against the dollar.

OPEC Optimism: The OPEC+ cartel is anticipating increased crude oil demand from India and China by 2026, suggesting a potential openness to lifting production cuts. Although the group’s next meeting is not scheduled until February 3, a growing sense of optimism regarding global economic recovery is emerging among its members. The potential for increased oil supply is likely to exert downward pressure on oil prices.

French Pension Plan: The country’s new prime minister, François Bayrou, has proposed “renegotiating” the controversial pension reform introduced by Emmanuel Macron, which raised the retirement age from 62 to 64. This offer appears to be an olive branch to leftists as he seeks support for passing the budget; however, he has maintained that any changes should not hurt the country’s public finances.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with news that Israel and Hamas could be on the verge of a cease-fire deal that could help stabilize the Middle East and reduce the risk of disruption in the global energy market. We next review several other international and US developments with the potential to affect the financial markets today, including new trade tensions between the European Union and China and more signs that investors are turning to data centers as a key way to capitalize on the development of artificial intelligence.

Israel-Hamas Conflict: Negotiators from Israel and the militant Hamas government of Gaza are meeting today in Doha, Qatar, to finalize a cease-fire deal that would end Tel Aviv’s attacks on the enclave and release some of the hostages held by Hamas. Officials from Qatar say the deal could be signed and announced as early as today. If signed and implemented, the deal could help stabilize the Middle East and ease concerns about the global energy market.

China-Taiwan: Western defense analysts have discovered that Chinese shipyards are building at least three large, unusual barges with the ability to extend road bridges from their bows. The ships are suspected of being prepared for an eventual Chinese invasion of Taiwan, despite many observers’ expectations that China would more likely impose a naval blockade to force Taiwan into unification with the mainland. Of course, either scenario would likely touch off a security crisis that could draw in the US and the rest of its geopolitical bloc.

European Union-China: The European Commission today said its months-long probe into the Chinese government’s procurement practices found that they discriminate against EU medical devices. The finding sets the stage for EU-China negotiations on changing the practices, but if no agreement is reached, then Brussels could impose retaliatory trade barriers against Beijing. The finding shows how the EU has increasingly aligned with US-style moves to counter China’s aggressive trade practices, which raises the risk of a wider global trade war.

European Union-United States: The European Commission has reportedly launched a review of how it is applying its new digital markets regulation against major US technology firms such as Apple, Meta, and Google. The review could lead to the EU probes against those firms being scaled back or narrowed. The reassessment is apparently linked to concerns that the CEOs of those firms have now become close to President-elect Trump and that tough enforcement action against them could prompt retaliation from the new US administration.

Mexico-China-United States: Mexican President Sheinbaum has announced a plan to cut her country’s big trade deficit with China and mollify critics who say Mexico is now a back-door conduit for Chinese goods being shipped to the US. Sheinbaum’s “Plan Mexico” seeks to boost investment and production in a range of Mexican manufacturing industries, including autos and textiles. If the plan successfully broadens and deepens Mexico’s industrial sector and better protects investors, it could give a boost to the Mexican economy and stock market.

US Demographics: In its annual demographic outlook, the non-partisan Congressional Budget Office lowered its forecast for future US population growth, largely because it now expects even lower fertility and reduced net immigration. The slowdown in population growth and the associated rise in average ages are expected to weigh on overall economic growth and put added fiscal pressures on the federal government.

• The CBO now forecasts that the US population will grow from 346.6 million in 2024 to 361.8 million in 2033, for an average annual growth rate of about 0.48%. In 2033, the CBO expects US deaths to start outnumbering births, meaning all growth thereafter would have to come from net immigration.
• Between 2033 and 2054, the CBO now expects the population to grow to 372.0 million, for an average growth rate in that period of just 0.13%.

US Artificial Intelligence Industry: Major Australian bank Macquarie has agreed to invest up to $5 billion in AI-infrastructure company Applied Digital. Almost $1 billion of that will help cover the costs of a data campus the firm is building in North Dakota, while the rest represents a right of first refusal to invest in future Applied Digital data centers for 30 months. The commitment by Macquarie is yet another sign that top investors see data centers as a major opportunity amid the build-out of computing infrastructure for AI models and applications.

US Military: Internal data shows that the US Army has already enlisted 30,000 new recruits since October 1, achieving almost half its goal of 61,000 for the entire fiscal year and reversing the historically weak recruitment of recent years. Historically, the armed services have struggled to recruit in strong labor markets, so the improvement this fiscal year so far could partly reflect the modestly higher rate of civilian unemployment since early 2023.

• The improvement also reportedly reflects the Army’s success with new recruiting programs.
• For example, since many youths today struggle to meet the Army’s physical-fitness and educational standards, the new programs help young people get into shape and boost their scores on the Army entrance exam. Other programs have helped by giving recruits more freedom in choosing their initial duty station.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a few words on the global bond sell-off, which so far this morning is still pushing yields higher. We next review several other international and US developments with the potential to affect the financial markets, including more signs that China is struggling with excess capacity in its industrial sector and new projections pointing to a boom in the construction of natural gas-fired energy plants in the US.

Global Financial Markets: Global bond yields continue to rise this morning, driven largely by outsized US economic growth and concerns about rising fiscal deficits. As we noted in our Comment on Friday, the strong December employment report has sparked speculation that the Federal Reserve may stop cutting interest rates. As a result, the US Treasury yield curve is decidedly upward sloping again, reflecting the current “bear steepening.”

• The prospect for continued fast economic growth and high interest rates in the US is also boosting the value of the dollar and punishing foreign currencies.
• For example, the euro so far today is trading down approximately 0.5% to $1.0202, while the British pound has plummeted 0.7% to $1.2121.

Global Uranium Market: The price for enriched uranium has hit a record $190 per separative work unit (the standard way to value the effort required to separate uranium into its various isotopes). That marks an enormous jump from $56 three years ago, mostly reflecting global plans to increase the use of nuclear power and looming Western sanctions against Russia, the main refiner of uranium.

• Enriched uranium is typically sold to nuclear generating firms under long-term contracts, so its value can diverge from spot prices for mined uranium. Indeed, while anticipated demand growth and looming sanctions drove up enriched uranium prices in 2024, spot prices were in a correction and fell some 28%.
• Importantly, the continuing rise in enriched uranium prices holds the prospect for a rebound in spot uranium prices. We continue to believe that spot uranium could offer solid investment returns in the coming years.

Eurozone: Philip Lane, chief economist at the European Central Bank, said in an interview that his institution should work to find a “middle path” to cutting interest rates further. According to Lane, the ECB policymakers need to find a rate-cutting path that would still push down price inflation but also support economic growth. Since Lane’s statement points to continued eurozone rate cuts, while investors now think US rates may be on hold, the news may be contributing to the euro’s weakness so far today.

Germany: Laying out the platform of the far-right Alternative for Germany (AfD) in next month’s election, party co-leader and chancellor candidate Alice Weidel stressed that an AfD government would push for the mass repatriation of immigrants. Specifically, Weidel used the controversial, expansive term “remigration,” which far-right politicians in Germany define as forcibly removing immigrants who either break the law or “refuse to integrate,” regardless of their citizenship status.

• Public opinion polls currently show AfD garnering about 20% of the February vote, second only to the center-right Christian Democratic Union, at about 32%. Nevertheless, AfD’s prospects for joining a government are in question, as Germany’s mainstream parties are all reluctant to strike a coalition deal with it.
• Nevertheless, the large chunk of the electorate that supports AfD illustrates the extent to which anti-immigration sentiment has risen in Europe. That suggests that European migration policy will continue to tighten going forward, despite the region’s falling birth rate and demographic challenges.

China: The China Photovoltaic Industry Association has complained that its new cartel aimed at curbing excess production and boosting prices is already being undermined by a Xinjiang solar energy project. In its search for solar panel suppliers, the project reportedly set a bidding limit far below the cartel’s price floor of 0.68 yuan ($0.09) per watt and awarded contracts to the firms with the lowest prices. The incident suggests that the Chinese solar panel industry will continue to struggle with excess capacity, falling prices, and vanishing profits.

• Along with electric vehicles, the solar energy industry is one of the best examples of how China’s industrial policies have created massive problems with excess capacity, high debt, and budding financial problems.
• Since China’s solar energy industry is mostly made up of relatively smaller private firms, it is proving hard to discipline. The government in 2024 issued new regulations to limit the investment in new capacity, but even the existing capacity is far more than enough to supply global demand.
• It now appears that the industry’s effort to build a self-regulating cartel also won’t stabilize prices or boost profitability. As producers export their excess production at fire sale prices in a desperate effort to survive, one result will likely be continued economic tensions between China and its trade partners.

Malaysia: In a Financial Times interview, Economy Minister Rafizi Ramli said Chinese technology companies are quickly ramping up their investments in Malaysia to get around the new US import tariffs that the incoming Trump administration is expected to impose against China. The government expects Chinese firms to invest billions of dollars in new production facilities in Malaysia in the coming years, giving a boost to economic growth.

United States-China: The outgoing Biden administration today unveiled new, expansive export controls on advanced computer chips for artificial intelligence. The rules aim to make it harder for China and other potential adversaries to acquire the chips, which can be used for both civilian and military purposes. Under the rules, 20 close US allies and partners will have uninhibited access to advanced AI-related chips with US technology, but most other countries will require licenses.

• The new rules tighten the Biden administration’s previous efforts to crimp Chinese access to advanced AI chips. The previous efforts have in some cases been undermined by loopholes and workarounds.
• At least temporarily, the new rules are likely to rile Beijing and the countries that will now be subject to US licensing requirements. However, it isn’t clear that the incoming Trump administration would maintain the rules. Given the strong influence that tech titans have in Trump’s circle, it would not be a surprise if they work to water down or reverse the Biden rules in order to preserve US tech firms’ access to the Chinese market.

US Energy Industry: Energy consultancy Enverus has issued a report saying the new data centers being built for the AI industry will spur the construction of some 80 new natural gas-fired energy plants in the US by 2030. The report builds on other analysis projecting the new data centers and their enormous energy requirements will also spur more nuclear power generation. However, gas-fired plants are cheaper and quicker to build, so it’s reasonable to expect they will satisfy much of the new electricity demand and potentially help drive gas prices higher.

US Insurance Industry: California Governor Gavin Newsom yesterday said the multiple wildfires that have destroyed some 40,000 acres of Los Angeles could be the costliest disaster in US history. AccuWeather estimates the total economic loss from the fires will be $135 billion to $150 billion, and early estimates suggest insured losses will be upward of $20 billion. Because of the high insured losses, property insurers are expected to suffer big losses and pull back from the California market, driving many property owners to the state’s backstop plan.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is reacting to the latest jobs data. In sports news, Real Madrid triumphed over Mallorca to advance to the final of the Spanish Super Cup. Today’s Comment will delve into the recent rise in UK gilt yields, explore the potential factors behind a prolonged conflict in Ukraine, and discuss other relevant market developments. As always, the report will include a summary of key international and domestic economic data releases.

Another Truss Moment? UK long-term bond yields soared to multi-decade peaks on Thursday, driven by escalating concerns about the nation’s ability to manage its burgeoning debt. The 10-year gilt yield reached 4.82%, its highest level since 2008, while the 30-year gilt yield climbed to 5.38%, its most elevated point since 1998. This surge in interest rates exerted downward pressure on the pound sterling (GBP), causing it to depreciate by 0.6% on the day.

• The cause of the market sell-off remains uncertain, but a potential contributing factor could be the growing tensions between London and Washington. It has been reported that Elon Musk, a prominent figure within the Trump administration, is rumored to be trying to oust UK Prime Minister Keir Starmer before the next election.
• Despite President-elect Donald Trump not having expressed any specific criticism of the UK, concerns linger regarding potential tariffs that could impede the nation’s economic growth. This anxiety emerges at a critical moment when the UK government depends on a strong economy to stave off the severe budget cuts needed to tackle the growing national debt.

• Since the United Kingdom voted to leave the European Union in 2016, it has had six prime ministers and has seen its general government debt surpass the total of GDP for the first time in at least 50 years. Hence, the rise in yields may be driven by the possibility of growing political instability and an increase in the government deficit.
• While the recent rise in yields is concerning, its moderate pace is unlikely to trigger a market rout similar to the one that occurred in 2022 following the release of the controversial mini budget under UK PM Liz Truss. However, the increase in borrowing costs could weigh on the economic growth of the country.

Another Lifeline? President-elect Donald Trump has extended the timeline for ending the conflict in Ukraine from 24 hours after taking office to six months. This shift in strategy appears to stem from concerns within the administration that a hasty resolution could be perceived as a rushed or poorly executed decision, potentially impacting the president’s public image.

• The reported U-turn also appears to be an olive branch to Europe, aimed at persuading the administration to sustain its support for Ukraine. Although the president campaigned on ending US funding for the war, he has been notably quieter on the issue since winning the election.
• In fact, just days after winning the election, Trump reportedly warned Russian President Vladimir Putin against escalating the war and reminded the Russian leader that the US “has weapons, too.”
• Despite President-elect Trump’s initial reluctance to end the war, discussions between the US and Russia appear to be taking shape. Trump is reportedly open to a peace deal that would allow Russia to retain control over several captured regions. However, Russian delegates have expressed dissatisfaction with the initial proposal.

• Although the end of the conflict is a positive development, investors should remain mindful that Russia remains a strong competitor to the US in the global energy market. A key takeaway from the conflict is that sanctions on Russia created new opportunities for US energy producers to capture market share in Europe. The administration’s desire for Europe to increase its reliance on US energy will likely lead to heightened scrutiny by the US administration regarding any resurgence of Russian energy exports.

Japan Inflation Optimism: There are growing signs that the country may have finally escaped its deflationary spiral. The Bank of Japan is expected to upwardly revise its inflation outlook. While the recent revisions have been attributed to an increase in rice prices and the depreciation of the currency, there are also increasing signs that wages have started to pick up.

• The central bank’s decision to raise its inflation forecast signals a stronger commitment to tightening monetary policy to counteract persistent price pressures and safeguard economic stability. This is likely to result in higher Japanese bond yields and a stronger yen (JPY). However, given the prevailing economic slowdown, the impact on equities may be mixed.

China’s Troubles Deepen: The People’s Bank of China has halted purchases of government bonds, a move widely interpreted as an attempt to dampen speculation about the country’s economic growth prospects. This action could further fuel fears of a deflationary spiral in the world’s second-largest economy.

• At the same time, the MSCI China Index seems poised to enter a bear market in the next few days as investors brace for escalating trade tensions between China and the US. On Friday, the index dropped by as much as 1.1%, bringing its total decline closer to 20% since its peak on October 7, 2024.
• Earlier this week, it was reported that outgoing President Joe Biden plans to announce new restrictions on AI chips as the US seeks to maintain its competitive edge over China in the sector.

• As noted in our previous reports, China is likely to face challenges stemming from the five Ds: weak consumer demand, overcapacity coupled with high debt, unfavorable demographics, economic disincentives due to the Communist Party’s market interventions, and the impact of Western decoupling in trade, technology, and capital flows.

DOGE’s Setback: Tesla CEO Elon Musk acknowledged on Wednesday that his newly formed Department of Government Efficiency may fall short of its ambitious goal of reducing the federal deficit by $2 trillion, potentially achieving only half of that target.

• While this news is disappointing amid the market’s strong preference for fiscal restraint, investor skepticism about the feasibility of Musk’s ambitious deficit reduction target was evident from the start.
• That said, we still believe that efforts to reduce government spending are likely to be bullish for bond prices.

Labor Talks: US dockworkers have reached a tentative agreement with their employers, averting a potential shutdown of East and Gulf Coast ports next week. This new deal includes provisions for a framework to address the impact of automation on the workforce, aiming to protect workers’ jobs as technology advances. If ratified, this agreement will have a six-year term.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Note: The Confluence offices will be closed tomorrow, January 9, for the Day of Mourning, and we will not publish a Daily Comment.

Good morning! Concerns about the deficit and inflation continue to weigh on investor sentiment. In sports news, New Orleans Pelicans forward Zion Williamson scored 22 points in a loss to the Timberwolves in his first game back from injury. Today’s Comment will cover our perspective on the rise in 10-year Treasury yields, tensions between the US and its allies, and several other key developments. As always, the report concludes with a summary of international and domestic data releases.

Long-Term Yields Rise: Equity prices plummeted after 10-year Treasury yields rose to their highest level since October 2023. A disappointing bond sale and broader concerns about a return of inflation drove the rise in interest rates. As a result, the S&P 500 fell 1.1% on the day, while the tech-heavy NASDAQ composite closed down 1.9%.

• On Tuesday, $39 billion of Treasury securities were auctioned at a concerningly high yield of 4.68%. This yield, marginally above the initial indicated level, signaled weak investor demand. While the 10-year Treasury rates reached 5% in 2023, the auction marked the highest yield for newly issued securities in over 16 years, raising concerns about the state of the Treasury market.
• Fears of a resurgence in inflationary pressures and tightening labor market conditions may have influenced the auction’s relatively weak performance. The December ISM PMI Services Index registered at 54.1, surpassing expectations of 53.3, with its sub-component prices index exceeding 60 for the first time since January 2024. Concurrently, the BLS Job Openings and Labor Turnover Survey (JOLTS) revealed a significant increase in job listings in November, rising from 7.839 million to 8.098 million.

• The weak auction and stronger-than-expected economic data will likely heighten market focus on the upcoming jobs report. The unemployment rate will be particularly scrutinized, as last year’s rise from 3.7% to 4.2% significantly influenced the Fed’s decision to cut rates by 100 basis points in 2024. A decline in the unemployment rate could jeopardize projected cuts unless inflation demonstrates a substantial decrease.
• The CME FedWatch Tool currently suggests only a 25-basis-point rate cut by the central bank for 2025. While this scenario seems plausible, we believe the possibility of rates remaining unchanged throughout the year remains significant, especially if inflation fails to demonstrate substantial progress, and the labor market remains tight in the coming months.

Rifts Emerge Within the Western Alliance: President-elect Donald Trump has proposed annexing Canada and Greenland, as well as renaming the Gulf of Mexico to the Gulf of America, signaling a dramatic shift in US policy. In a news conference, Trump declined to rule out the use of military or economic measures to achieve these ambitions, further raising tensions.

• Western allies have unsurprisingly dismissed Trump’s attempts to acquire additional territory, warning of potential retaliation if aggression occurs. French Minister Jean-Noël Barrot stated that the EU is ready to defend the sovereignty of its members against any use of force. Similarly, Canadian PM Justin Trudeau firmly rejected the idea of being annexed by the US and implied that force would not be beneficial to either side.
• The move coincides with the incoming administration’s shift away from the US’s traditional role as a benevolent hegemon. This administration appears poised to adopt a more assertive, potentially even adversarial, foreign policy. Consequently, they are likely to prioritize transactional agreements that maximize national self-interest.

• Currently, financial markets seem to be discounting the risk of a significant rift between the US and its allies. Investor attention remains largely fixated on domestic concerns like inflation and the growing national debt. However, escalating tensions between the US and its allies could inject renewed uncertainty into global markets. This increased volatility could bolster demand for traditional safe-haven assets like gold and silver.
• As US global influence wanes, we anticipate a rise in demand for alternatives to the dollar. Gold and silver are likely to emerge as contenders. The current gold-to-silver ratio exceeds 80, significantly higher than the 30-year average of 67, suggesting gold’s relative expensiveness compared to silver. However, this elevated ratio may now be the norm, given its consistent range between 80 and 90 over the past four years.

Virginia Election Races: The first political test following Donald Trump’s victory brought no surprises in Virginia. Democrats retained two State House seats in left-leaning Loudoun County, while Republicans held onto their State Senate seat. The closely watched contest was seen as an early indicator of the state’s political direction for when Republican Governor Glenn Youngkin’s term ends next year.

Immigration Bill: The new Congress has passed its first bill of the year, the Laken Riley Act, which mandates the detention of undocumented immigrants for non-violent offenses such as theft. This legislation is likely the first in a series of measures aimed at restricting immigration. Financial markets will closely monitor the potential impact of this crackdown on the labor market, as it could exacerbate labor shortages and push up wages for businesses.

China’s Woes Continue: The country’s currency fell to a 16-year low due to fears that the Trump tariffs are likely to complicate the country’s growth efforts. Prior to this escalation, the country had been grappling with sluggish growth and deflation, exacerbated by waning investor and consumer confidence.

• The negative sentiment has also spread into the country’s bond market with the yield on 30-year government debt falling below the psychological level of 2%, placing it below the current level in Japan.

• A weakening Chinese economy poses a significant risk to global growth, as subdued consumption in the world’s second-largest economy will inevitably impact global demand. While the US remains an attractive destination for equity investments, we believe that compelling opportunities exist in international markets, particularly when analyzed on a sector-specific or individual stock basis.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with new US moves to constrain the Chinese economy and military buildup. We next review several other international and US developments with the potential to affect the financial markets today, including some notes on yesterday’s resignation of Canadian Prime Minister Trudeau and a positive new outlook for artificial-intelligence darling Nvidia.

United States-China: The Department of Defense yesterday put a slew of additional high-profile Chinese companies on its list of firms that support the People’s Liberation Army. Firms added to the list include social media giant Tencent, electric-vehicle battery maker CATL, and shipping firm COSCO. Companies on the list aren’t automatically sanctioned, but Western firms and investors typically become skittish about doing business with them or investing in them.

• The action appears to mark yet another of the Biden administration’s parting shots at Beijing and its military.
• Biden’s outgoing China hawks may fear that President-elect Trump will be convinced by the Chinese and/or the internationalist business interests in his administration to go soft on Beijing. Indeed, Trump’s recent moves on immigration and tariffs suggest he will favor his corporate supporters over the populist nationalists in his coalition.
• As we outlined in our recent Outlook 2025 report, “Technology Sector Supporters” are a key part of Trump’s coalition. This constituency includes many tech leaders who hadn’t been close to Trump in the past but are investing heavily to curry favor with him to protect their business interests both domestically and internationally.
• In the latest example of this today, Meta CEO Mark Zuckerberg said Facebook and Instagram will stop fact-checking and end speech restrictions, aligning the platforms with Trump and his incoming administration.

North Atlantic Treaty Organization: In an interview with the Financial Times today, the chief of the NATO’s military committee said Western rating agencies, banks, and investors are being “stupid” for not investing more in defense companies. Consistent with our own analysis here at Confluence, Adm. Rob Bauer pointed to the huge amounts of new money European governments are pouring into defense rebuilding. We continue to believe that European and Asian defense stocks are especially well positioned to benefit from this new spending.

Eurozone: The December consumer price index was up 2.4% from the same month one year earlier, accelerating from a rise of 2.2% in the year to November and 2.0% in the year to October. Eurozone price inflation has now accelerated for three straight months and remains above the European Central Bank’s target of 2.0%. Because of the eurozone’s sluggish economic growth, the ECB is still expected to cut interest rates at its January 30 policy meeting, but sticky inflation will complicate the outlook for further rate cuts.

Canada: Prime Minister Trudeau announced his resignation yesterday, finally bowing to his many critics both within his Liberal Party and outside of it. The deeply unpopular Trudeau said he will stay on as prime minister until the party picks his successor, which could take several months. To forestall a no-confidence vote in the meantime, he also suspended parliament.

• Trudeau is the latest of the world’s progressive national leaders to lose power over issues such as weak economic growth, high price inflation, burgeoning debt, burdensome new climate regulations, and rising immigration.
• Going forward, Trudeau’s resignation leaves Pierre Poilievre and his right-wing Conservative Party in pole position to win Canada’s next parliamentary election. If Poilievre were to become prime minister, he would likely push pro-growth policies such as tax cuts and deregulation.

US Monetary Policy: Fed Vice Chair for Supervision Michael Barr yesterday said he will resign his regulatory role in February but will remain on the central bank’s board of governors. Barr has pushed for tough bank regulations, raising the prospect of conflicts with the incoming Trump administration and its plan to push for deregulation. Now, that prospect of conflict is much reduced, as Trump will be able to nominate his own vice chair from the other remaining Fed governors.

US International Trade Policy: Yesterday, President-elect Trump denied the Washington Post’s early morning report that his proposed big import tariffs would be limited to critical goods. True to character, he described the report as “fake news.” In response, the US dollar regained much of the value it had lost early in the day, with the US Dollar Index closing down only slightly.

US Economy: According to S&P Global, at least 686 companies in the US filed for bankruptcy in 2024, up about 8% from 2023 and the most since 2010, when filings associated with the Great Financial Crisis peaked at 828 filings. The report is a reminder that despite the US economy’s continued strong growth and moderating price inflation, it still has pockets of weakness. High interest rates have probably been one key reason for the rise in business failures.

US Technology Sector: Nvidia CEO Jensen Huang yesterday laid out a future vision for the firm that encompasses not only more growth in its current business of producing chips for developing artificial-intelligence systems, but also “trillions of dollars” of opportunities in areas such as robotics and self-driving vehicles. Given that Nvidia has been such a key driver of the US stock market over the last couple of years, a credible outlook for continued strong growth that can keep the stock’s price moving upward is important to the overall US market.

US Financial Services Industry: According to the Financial Times, the US private-equity industry is preparing to lobby the incoming Trump administration to broaden the types of investors that can invest in its funds. For example, one deregulation goal would be to allow defined contribution retirement plans, such as 401(k)s, to invest in private-equity funds.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our first Comment of the New Year opens with the same old geopolitical tensions in Asia, this time with reports touching China, Taiwan, and Japan. We next review several other international and US developments with the potential to affect the financial markets today, including the new French government’s decision to ease its deficit-cutting target and news that President-elect Trump will try to pass all of his major policy initiatives in a single bill once the new Congress is in place.

China-Taiwan: Beijing has reportedly launched a new program under which Taiwanese visiting the mainland are being urged to sign up for local resident cards, bank accounts, and mobile-phone numbers, which in total allow them to apply for the identity cards used by Chinese citizens. The program appears to be another effort by Beijing to undermine Taipei’s jurisdiction over Taiwan. In a worst-case scenario, it could also be used as an excuse for Beijing to intervene in the island’s domestic affairs or even to invade.

Japan: New reports say Tokyo will release its first-ever arms export plan sometime this year. Developed with Japanese industrial firms, the plan will lay out medium- and long-term targets for defense equipment exports. Its goal will be to strengthen Japan’s arms makers so they can better support the country’s defense buildup ahead of a potential conflict with China. Development of the plan illustrates how defense is becoming a growth industry worldwide, but especially in Asia and Europe.

• According to the authoritative Stockholm International Peace Research Institute, the world’s 100 largest defense firms boosted their total domestic and foreign arms revenues to $632 billion in 2023, for an inflation-adjusted increase of 4.2% from 2022.
• The five Japan-based companies in that total — Mitsubishi Heavy Industries, Kawasaki Heavy Industries, Fujitsu, NEC, and Mitsubishi Electric — increased their total defense revenues to $10 billion, up 35% on the year.
• As in many other countries, the Japanese budget for reconnaissance and strike drones is rising especially fast, reflecting both their critical role in the Ukraine war and troop recruiting challenges related to Japan’s low birthrate.

France: The new minority government of Prime Minister Bayrou today said it would only try to cut the budget deficit from an estimated 6.1% of gross domestic product in 2024 to a range of 5.0% to 5.5% in 2025. Ostensibly to help protect economic growth, the target would be a bit easier to achieve than the 5.0% planned by the previous prime minister before he lost power in a no-confidence vote. Since it would also require smaller tax hikes and spending cuts, the new target also has a better chance of being passed by parliament and averting a fiscal crisis.

US International Trade Policy: We noticed a headline on Bloomberg television today saying the enormous tariffs that President-elect Trump has threatened to impose on foreign imports will only apply to “critical” inputs. However, we still have not seen the details behind the report. In any case, the news appears to have pushed the US dollar sharply lower against most major foreign currencies so far today. As of this writing, the US Dollar Index is down 0.9% to 107.95.

US Fiscal and Regulatory Policy: President-elect Trump and House Speaker Johnson have reportedly decided to pursue a single mega-bill encompassing all the Republicans’ major policy priorities once the new Congress is in session later this month, rather than the two-bill strategy considered previously. The single bill would include everything from extending and expanding the 2017 tax cuts and cutting spending to cracking down on immigration and deregulating the energy industry.

• Because of the Republican party’s very narrow majorities in Congress, both the strategies have political risks. A single bill covering such a large number of issues may also take much longer to be passed. Observers currently think such a bill couldn’t be signed into law until at least late April or May.
• In any case, the policies covered by the bill would be in sync with a recent research paper by Steve Miran, the incoming chair of Trump’s Council of Economic Advisors. In his paper, Miran argues that boosting growth would best be achieved by slashing regulation to incentivize more investment related to artificial intelligence and other technologies required for military modernization.

US Monetary Policy: In a speech Friday, Richmond FRB President Barkin said the continued strength in the labor market and waning price pressures mean there are more upside risks than downside risks to economic growth in 2025. However, he warned that such a scenario means there are also more upside than downside risks to inflation. Barkin’s statement is consistent with our view that the Federal Reserve may cut interest rates less than expected this year.

US Critical Minerals Mining Industry: The US Forest Service late Friday granted a permit for Perpetua Resources’ “Stibnite” gold and antimony mine in Idaho. When it starts producing in 2028, the mine is expected to supply some 35% of the nation’s demand for antimony, a rare mineral used in armor-piercing ammunition, solar panels, and other high-technology goods. In response to the news, Perpetua’s stock price surged 9.1% in after-market trading.

• Antimony is not currently produced in the US, and Beijing has recently restricted its exports to retaliate for Washington restricting the sale of advanced semiconductor technology to China. Approval of the mine illustrates how US-China tensions and global fracturing have spurred re-industrialization in the US, especially regarding goods critical to national security and advanced technologies.
• Although US industrial firms are often constrained by stringent environmental and other regulations, we think the US’s new prioritization of defense and economic growth could lead to those rules being watered down. If so, we could see many more examples of new mining and other industrial investments related to defense and technology.
• Indeed, the US defense budget and industrial-development programs could provide much of the funding for these investments. In fact, the $1.3-billion Stibnite project has been partly funded by the US Export-Import Bank and the Defense Department.

US Commercial Real Estate Industry: The Wall Street Journal today has an interesting article on the shortage of space at open-air shopping centers and the resulting strong performance of real estate investment trusts (REITs) focused on retail properties. The article notes that the sector has benefitted from reduced construction after the Great Financial Crisis and work-from-home rules that allow people to shop throughout the week. The article illustrates why investors may not want to avoid REITs entirely, despite the current challenges facing the office sector.

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