Author: Amanda Ahne

Daily Comment (April 17, 2025)

Posted on by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning. Global monetary policy concerns are currently a key focus for the market. In sports, reigning Champions League titleholders Real Madrid were eliminated by Arsenal. Today’s Comment will address recession fears in Canada, the Federal Reserve’s policy stance amid tariff uncertainty, and other market-moving developments. As always, this report will include domestic and international data releases.

Trouble Up North? The Bank of Canada became the first G-7 central bank to flag a trade war as a potential recession trigger.

  • Canada’s economic vulnerability and heavy reliance on US trade have elevated this election to historic importance, with the outcome likely shaping how the nation weathers a potential trade conflict with its southern neighbor. The Conservative candidate previously enjoyed what seemed to be an insurmountable advantage just months ago, but the political landscape has shifted decisively as voters perceive PM Mark Carney as being best equipped to counter President Trump’s assertive approach toward trade talks.
  • As the global order fragments into economic blocs, stronger US-Canada alignment could foster coordinated policy responses to address shared concerns about China’s economic and geopolitical ambitions. We believe that Carney’s pragmatic stance positions him favorably for negotiations with the Trump administration. His recognition of Canada’s limited retaliatory capacity in trade disputes underscores his unwillingness for an out all out back and forth between the two countries.

Fed Concerns? Federal Reserve Chair Jerome Powell hinted that tariff uncertainty may lead the Fed to hold rates unchanged for the rest of the year.

  • During a speech at the Economic Club of Chicago, Powell warned that trade uncertainty has complicated the Federal Reserve’s efforts to fulfill its dual mandate of maximum employment and price stability. He noted that the current tariff levels far exceed the Fed’s worst-case projections, potentially forcing the central bank to adopt a more cautious, wait-and-see approach to interest rate policy. With Fed officials still uncertain about whether to prioritize inflation control or unemployment, the path forward remains unclear.
  • Powell’s lack of explicit guidance has raised market concerns that the Fed may deliver fewer rate cuts than anticipated. According to the CME FedWatch Tool, investors currently assign a 64% probability to three or four rate cuts this year. This uncertainty triggered a mild equities sell-off, as traders grew skeptical that the central bank would intervene to cushion a sharp market downturn — a phenomenon known as the Fed put.

  • While the Fed and the market are concerned about rising inflation and slowing GDP growth (aka stagflation), it’s important to note that true stagflation is exceptionally rare. The last significant occurrence in the US was in the 1970s and was driven by the Arab oil embargo. Given that oil prices have declined and broader economic data remains relatively stable, we believe it’s too early to determine the economy’s true trajectory.
  • Despite concerns over trade policy, we believe the Fed is likely to keep its policy tools available to address economic risks. While Chair Powell has signaled hesitation about easing policy amid elevated inflation risks, we expect the central bank’s stance could shift swiftly in the event of a severe disruption, such as a sudden spike in defaults or emerging liquidity strains. Barring such shocks, however, the Fed will probably remain on hold and allow developments to unfold.

Trade Talks Progress: Giorgia Meloni, Italy’s Prime Minister, aims to strengthen US-EU ties, while Japan and the US maintain ongoing discussions.

  • Prime Minister Meloni is scheduled to meet with President Trump on Thursday, following the breakdown of recent EU-US trade negotiations. Her shared populist background with the US president has positioned her as a potential mediator. The visit occurs amidst EU accusations that the US failed to articulate its specific demands for a trade agreement. During those negotiations, the EU offered to eliminate all tariffs if the US reciprocated. The White House rejected this proposal, insisting on a 10% baseline tariff.
  • Despite the lack of progress in EU negotiations, the Trump administration has made headway in discussions with Japan. While specific details remain undisclosed, a second round of negotiations is anticipated later this month. It is expected that both sides will seek agreements on trade and defense.
  • US discussions with the EU and Japan are expected to be intense as they aim to establish a framework for an agreement before the 90-day exemption period expires. Given that the deadline is anticipated to near the Fourth of July holiday, we believe an arrangement will likely be finalized in time for the president to potentially use it as a marketing tool.

US-Iran Talks: The two sides have agreed to hold talks in Rome about Iran’s nuclear program this weekend.

  • US officials met with their Iranian counterparts last Saturday in Oman for the first round of discussions. The two sides are currently working to define their ultimate objectives regarding Iran’s nuclear capabilities. Complicating matters, Iran has accused the US of moving the goal post from first aiming to limit its nuclear capability to now wanting to shut it down completely.
  • The disagreement over what the US aims to achieve in talks with Iran appears to be driven by internal divisions within his inner circle. President Trump has made it clear that he would like to prevent Iran from weaponizing its program and creating a nuclear bomb. This comes after he refused to support Israel’s desire to strike Iran’s nuclear sites as soon as next month.
  • Ongoing discussions are likely a positive for the market as they reduce the likelihood of conflict. Trump appears unwilling to pursue military action if a deal can be reached, potentially paving the way for an agreement between the two sides in the coming months.

Note: There will be no Daily Comment published tomorrow due to the holiday.

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Asset Allocation Quarterly (Second Quarter 2025)

Posted on by Amanda Ahne

by the Asset Allocation Committee | PDF

  • Our three-year forecast includes an economic slowdown in the near term and potential recovery later in the period.
  • As the recession likelihood has increased significantly, we are reducing risk across the portfolios.
  • Trade and fiscal policy uncertainty will continue to dampen business investment as well as consumer and investor sentiment.
  • Monetary policy is likely to ease modestly in response to recessionary conditions; however, the degree of easing may be restrained due to inflation concerns.
  • Domestic equity exposure includes large and mid-caps, but we exit small caps this quarter.
  • International developed equities are attractive given a weakening US dollar, favorable valuations, and the repatriation of foreign investment in the US.
  • Gold and long-term Treasurys remain in the portfolios to curb volatility.

ECONOMIC VIEWPOINTS

Uncertainty surrounding trade policy is a key driver of our forecast this quarter, which includes an increased probability of a recession. At the time of this writing, the latest US trade policy includes the implementation of a 10% universal minimum tariff on goods from most countries, with higher, reciprocal rates applied to imports from countries that impose their own barriers on US exports, namely China. These tariffs are designed to shift global trade relationships through a mix of protectionism and leverage for future negotiations. Crucially, the on-again, off-again tariff policy, including shifting exemptions and the prospect of bilateral negotiations, has added to business uncertainty.

The lack of clarity in the magnitude, scope, and duration of trade measures is expected to have tangible economic effects, particularly on business, consumer, and investor activities. Surveys indicate that small business owners are increasingly doubtful about whether now is a good time to expand. Consequently, potential delays in capital expenditures could hamper long-term growth. US manufacturing construction spending has more than doubled since 2022, driven by reshoring efforts and policy incentives like the CHIPS Act. The rapid rise reflects major investment in sectors such as semiconductors and clean energy. As of 2024, spending has plateaued, suggesting a pause amid growing policy and cost-related uncertainties.

The economy was already losing momentum prior to the new tariffs, which when implemented could further exacerbate recessionary pressures. The Leading Economic Index (LEI) serves as a predictive tool, anticipating turning points in the business cycle. The most recent detrended LEI reading has fallen to levels last seen during the Great Financial Crisis (recessions marked by gray shading in the chart). A recession has been avoided mostly due to expansive fiscal policy, but the combination of tariffs and the lack of additional fiscal stimulus (extending the current tax rates avoids hikes but has little additional fiscal impact) means the recessionary signal offered by the LEI may become relevant. The downturn reflects a sharp deterioration in consumer expectations and a pullback in manufacturing new orders, both key components of the index.

Amid heightened policy uncertainty, the slowdown in business investment may result in an unwinding of labor hoarding, a key factor that has supported employment metrics despite moderating growth. While aging demographics and unresolved immigration policy provide structural support to the labor market over the long-term, near-term pressure may intensify the slowdown. Plunging consumer sentiment, driven by rising costs and the turbulent trade policy environment, is expected to weigh on consumption. Should labor markets deteriorate further, the US economy’s primary growth engine, consumer spending, could lose momentum. At the same time, frictional costs from tariffs, supply chain realignment, and elevated input costs are likely to sustain inflation above the Federal Reserve’s 2% target, even as growth moderates. These mixed signals will make it harder for the Fed to appropriately react to underlying economic conditions. We expect the federal funds rate to decline gradually in response to recessionary conditions; however, rates are unlikely to fall as low as they did during the last bear market. In this environment of elevated volatility and shifting policy dynamics, assessing the underlying strength of the economy remains increasingly complex for both investors and policymakers.

STOCK MARKET OUTLOOK

The introduction of sweeping tariffs and the resulting uncertainty around international trade relationships carry meaningful implications for equity markets. The shift in global trade policy represents more than just a near-term market disruption; it marks a potential paradigm shift in global investing. As the US becomes entangled in potential trade wars, creating heightened geopolitical risk and policy unpredictability, the US equity markets’ traditional status as a global safe haven may be challenged, potentially leading to slower capital inflows and elevated volatility. While near-term impacts are uncertain, tariffs tend to constrain supply, raise costs, and weaken profitability, especially in sectors reliant on global trade.

We have moved to a more defensive posture in our equity allocations, including a 40/60 weight on the growth/value style bias to reflect the increased recession likelihood. Large cap equities should continue to benefit from passive flows, while mid-cap equities offer valuation expansion potential. We added dividend-focused ETFs to the large and mid-cap allocations as dividends may become more important as volatility rises. Given our heightened recession outlook, we exited small cap equities. Small caps historically underperform in downturns due to their higher sensitivity to economic cycles, particularly when financial conditions tighten and market volatility increases. This move reflects a shift toward more defensively positioned assets with greater liquidity.

In sector weights, we maintain the exposure to advanced military technologies given rising geopolitical tensions. Potentially challenging conditions for US defense spending has led us to exit our cybersecurity position. We added Consumer Staples sector exposure as a defensive position amid economic uncertainty. Lastly, we exited the uranium position as this commodity isn’t expected to perform well during downturns.

We initiated an allocation to international developed markets. We expect the US dollar to weaken due to a combination of policy and macroeconomic factors, which could support foreign investment returns for dollar-based investors. Additionally, international developed equity valuations remain compelling. Europe, in particular, is well-positioned to benefit from improving growth outlooks due to eased regulations surrounding fiscal stimulus. In a sense, the pressure on European policymakers is encouraging fiscal adjustments that previously seemed unfeasible.

Our foreign developed market exposure also includes a position in a Swiss franc currency ETF. The franc has historically appreciated during periods of global monetary uncertainty and dollar softness, and it provides regional exposure to Europe without the political and fiscal risks embedded in the eurozone. Switzerland’s  strong current account surplus, low debt levels, and independent monetary policy enhance its appeal as a safe, high-quality European-linked currency. This position allows the portfolios to benefit from foreign exposure with less overall equity market risk. The heightened uncertainty around a potential trade war with China keeps us out of emerging markets.

BOND MARKET OUTLOOK

The mercurial approach by the US to both trade and geopolitical events will lead to uneven inflation prints through the course of our three-year forecast. Although we expect the general level of inflation to remain well below levels recorded at the height of the post-COVID regime, we remain doubtful that the Fed will be able to engineer a return to its oft-cited 2% target. Rather, trade policies and economic responses are likely to lead to CPI prints averaging closer to a 3% level, especially if the Fed responds to economic weakness with a series of rate cuts over the next year or two. Given our expectations for heightened inflation volatility, our forecast is for a modestly sloped normal yield curve to prevail over the next three years. A smaller number of Fed rate cuts may limit long-term interest rate declines and reduce the likelihood of a yield curve inversion. Nevertheless, real returns above the rate of inflation will continue to reward savers. Although we extended duration slightly, the preponderance of the bond exposure in the strategies with an income component remains in the intermediate maturity segment.

Among sectors, we continue to emphasize Treasurys and mortgage-backed securities (MBS). Regarding the latter, the high level of refinancings several years ago in the ultra-low-rate environment continues to suppress prepayment speeds and limits duration extension in seasoned MBS. In addition, discounted prices on these securities offer a cushion with volatile rates and the potential for upside performance should we experience a lower rate environment. In contrast, we hold a less than sanguine outlook regarding intermediate to long-term investment-grade corporates. In a challenged economy, their current tight spreads to Treasurys are expected to widen and return to historic levels. Similarly, speculative grade bonds are trading at option-adjusted spreads well below where they trade in an economically challenged and uncertain market. Accordingly, we significantly reduced the speculative grade exposure, with the small positions remaining solely in higher-rated BB credits.

OTHER MARKETS

We maintain gold exposure across all strategies and have selectively increased our allocation in certain portfolios. Gold continues to serve its intended role in the portfolios, offering stability during periods of elevated uncertainty. Persistent central bank demand underscores its importance as a reserve asset and inflation hedge. With rising geopolitical tensions and a push to diversify away from the US dollar, we expect this trend to continue, reinforcing gold’s strategic role in portfolio construction.

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Asset Allocation Fact Sheet

Keller Quarterly (April 2025)

Posted on by Amanda Ahne

Letter to Investors | PDF

Many readers of this letter have a personal history with that grand old firm, A.G. Edwards & Sons. In January, we alumni bid farewell to a dear friend, respected colleague, and larger-than-life individual, Al Goldman. As that firm’s longtime market analyst and strategist, Al was well-acquainted with every market move one could imagine. If he were writing this letter, I know exactly how he would begin it. We both loved T.S. Eliot and he would have quoted the opening line of The Waste Land.

April is the cruelest month… This second quarter has gotten off to a strange and ugly start. Economists have a rather quaint term for a mistake made by government leaders: policy error. By mistake, economists mean a decision that produced an economic outcome which the policymaker almost certainly did not intend. I don’t think a policymaker ever intends the result of their actions to produce a recession or some other terrible outcome; rather, they expect that their actions will produce something good for the economy. But since the future is hard to predict, and since economic variables are so complex, it is exceedingly difficult to know what the outcome of an economic policy change will be. Unfortunately, policymakers are rarely so humble as to admit their decisions could possibly have negative surprises.

My experience is that the immediate cause of most recessions is none other than policy error. This doesn’t mean recessions wouldn’t have eventually happened anyway, but they usually occurred when they did because of a decision made by economic policymakers in Washington. The Fed gets the blame most of the time. Often, they are raising interest rates in order to head off rising inflation or a bubble in asset prices. But, regarding interest rates, it’s very hard to know how high is too high. By too high, I mean high enough to cause a recession. The Fed has been working on this for decades and, I’m sorry to say, they have a track record of overdoing it: raising rates so high that a recession is induced.

These thoughts were occasioned by the events of the last two weeks. This time, the so-called policy error came from the White House. I take President Trump at his word when he says he wants to bring more high-paying manufacturing jobs back to the US. He had telegraphed that he would use tariffs to restrict competition from foreign-made goods and thus protect and nurture US manufacturing. But the size and breadth of the tariffs he proposed on April 2 went well beyond what Wall Street expected. Those tariffs would have slowed global trade to a crawl and raised the probability of a global recession. I say “would have” because on April 9 the president paused the most onerous tariffs for 90 days, whereupon the market breathed a sigh of relief.

As with Fed policy errors, I doubt the president was intending to cause a recession but was rather expecting a good outcome in the long run. In the opinion of the markets (and me), the short-term pain he was expecting would be much worse than he anticipated. Fortunately, he responded to market feedback with the adjustments on April 9. He left in place the 10% base tariff (something the market had expected) and only kept extremely high tariffs on China. This change has, in my opinion, greatly reduced the probability of recession, provided this pause is extended or made permanent. Markets have a way of influencing policymakers away from trouble, and we hope the paused tariffs stay that way.

As a securities analyst for the last 45 years, I’ve had a front row seat to the drama of job losses in the US manufacturing base since the late 1970s. Prior to that time, the US protected many of its manufacturing industries through restrictive trade policies. While those policies did a pretty good job of protecting those industries and associated jobs, they had a side effect: inflation. Restricted competition means restricted supply of goods, which results in inflation. Remember, inflation is too much money chasing too few goods. We tend to focus on the money side of the definition because it’s easy to measure, but my experience is that change in supply (too few goods) is the real inflation culprit most of the time.

Eventually, inflation became public enemy #1 and voters gave Washington the job of reducing inflation, which they accomplished primarily by allowing foreign-made goods into the US market. The increased supply of goods (usually manufactured at lower costs) allowed inflation to moderate. But as the economist Thomas Sowell says, “In economics there are no solutions, only trade-offs.” And the trade-off here was that low-cost, low-inflation foreign supply damaged US jobs as off-shore competition forced the shutdown of US manufacturers. The result was stagnating real household income for the last 40 years, especially for the nearly two-thirds of US workers who do not have a college degree.

So, here we are, almost 50 years later, and many US voters have indicated they want a different model. But what took 50 years to implement cannot be undone in a few months. It will take years and, according to Sowell’s dictum, there will be trade-offs. We suspect that, in the short run, a recession may result, and, in the long run, inflation will run hotter than we are accustomed to.

What’s an investor to do? I came of age in the high-inflation era, and I believe what worked then will work now. Own stocks of high-quality companies that have pricing power, the result of substantial competitive advantages. Keep fixed income maturities relatively short. And own some gold.

With Al’s passing, the three A.G. Edwards men who taught me the most about stocks and markets are gone: Al Goldman, Derick Driemeyer, and Oliver Langenberg. I learned so much from each. As I recently told a new Confluence employee, “This is an apprenticeship business.” There are no schools that teach this. We learn on the job from our mentors.

Al, I don’t have Jake the Labrador, but I do have Dolly the Newfoundland. And she says, as always, “All is well.”

We appreciate your confidence in us.

 

Gratefully,

Mark A. Keller, CFA
CEO and Chief Investment Officer

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Daily Comment (April 16, 2025)

Posted on by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The markets are weighing the latest retail sales. In sports, both the Golden State Warriors and Orlando Magic have clinched playoff berths in the NBA. Today’s Comment will focus on interpreting what import prices indicate about inflation pressures, examine the White House’s growing openness to tax increases, and analyze other key market developments. As usual, the report will include a summary of domestic and international economic data releases.

Tariff Update: Recent import price data suggests that tariffs have not yet translated into increased inflation. Nevertheless, trade concerns remain.

  • The latest trade price figures revealed a 0.1% decline in import prices during the first complete month following the new tariff implementations. This was the first monthly decrease since September 2024. The downward movement was principally fueled by a significant 2.3% drop in petroleum prices. When excluding petroleum, import prices were unchanged from the previous month. Export prices also showed no meaningful change from the previous month’s levels.
  • The muted inflationary impact of recent tariffs has provided temporary relief to policymakers, though uncertainty lingers regarding the Fed’s next moves. Boston Fed research shows import prices account for 10% of core PCE, comprising 6% from direct passthrough effects and 4% through secondary channels. This structural relationship has intensified market worries that sustained trade restrictions may keep monetary policy on hold through year-end, potentially delaying anticipated rate cuts.

  • Nevertheless, several Fed officials continue to highlight lingering risks. Richmond Fed President Thomas Barkin cautioned that while businesses have managed to maintain inventories thus far, consumers could still face price increases by June. He further warned that ongoing tariff-related uncertainty may delay the timeline for potential rate cuts. Atlanta Fed President Raphael Bostic highlighted that the Federal Reserve would adjust its policy once it has a better understanding of where trade policy is going.
  • This month’s import price data is significant because it indicates that the impact of trade restrictions on price pressures is currently lagging. This delay could be due to factors like discounts for bulk orders placed before tariffs or absorption of some tariff costs. Consequently, we caution that while tariffs will likely lead to higher costs for consumers and suppliers, the overall effects remain uncertain.

More Taxes: Raising taxes on wealthy individuals and corporations is gaining momentum within the Trump administration as it aims to offset the costs of proposed middle-class tax cuts.

  • While no final decision has been made, President Trump is reportedly considering corporate tax rate increases as a potential revenue source to offset proposed payroll tax cuts. Simultaneously, Republican lawmakers are drafting legislation that would introduce a new 40% tax bracket for individuals earning over $1 million annually. These discussions emerge as the administration faces challenges in financing its new tax package.
  • The proposal to increase the top marginal tax rate from 37% to 40% reflects growing Republican concerns about the deficit’s impact on national debt. While some GOP members worry that the new tax bill could exacerbate fiscal shortfalls, attempts to offset costs through cuts to Medicare, Medicaid, and Social Security face significant political resistance due to potential backlash.

  • The GOP’s openness to tax increases represents a striking break with party orthodoxy, challenging its decades-long commitment to tax reduction — especially for top earners. This ideological evolution reflects the rising sway of populism in Republican economic policy. The shift coincides with a broader realignment of political coalitions, as affluent suburban districts increasingly favor Democrats while working-class areas trend Republican, a transformation years in the making.
  • Proposals to raise taxes on corporations and high earners should be viewed skeptically until formally enacted into law. Even if included, such measures would likely be offset by other tax provisions and may primarily serve as political insulation against Democratic claims that Republicans favor the wealthy. That said, successful passage could establish a precedent for future wealth-focused tax increases, potentially reshaping the party’s fiscal approach to align with its evolving populist base.

Tech Concerns: A clouded outlook from ASML as well as new trade restrictions on chips has weighed on the tech sector.

  • Dutch semiconductor equipment leader ASML has warned that persistent tariff uncertainty is significantly obscuring its visibility for 2025-2026. The company’s disappointing first-quarter net bookings — a critical forward-looking metric — fell short of analyst expectations, suggesting potential headwinds for the global semiconductor sector. Compounding these challenges, management acknowledged difficulty in quantifying the potential earnings impact of escalating trade tensions.
  • Nvidia faces intensified regulatory challenges as the Trump administration expands its semiconductor export controls, adding the company’s flagship H20 AI processor to the China trade blacklist. The new restrictions, which require special licensing for all future China exports with no defined expiration, could force Nvidia to absorb a significant $5.5 billion Q1 write-down on previously approved shipments. This represents one of the largest financial hits yet from the ongoing US-China tech decoupling.
  • One critical consideration throughout this trade war is monitoring companies with substantial foreign revenue exposure. These multinational firms face heightened risks as global markets adapt to escalating tariffs. Consequently, investors may find defensive opportunities in domestically oriented businesses that are less vulnerable to international trade disruptions.

Japan Test Case? The US has prioritized Japan as it seeks to establish a framework for trade negotiations with major global economies.

  • Japanese negotiators are scheduled for direct talks with President Trump to address bilateral trade imbalances and ongoing military cooperation. While the Trump administration has indicated that it intends to maintain at least 10% baseline tariffs, Tokyo is reportedly advocating for their complete elimination. These discussions follow the US president’s recent push to impose 24% reciprocal tariffs on Japanese goods.
  • Trade negotiations between the two will provide a lot of insight into the flexibility of the Trump administration, which has been known to drive a hard bargain. If they are able to show more leniency in response to getting some concessions from trade partners, then the market could regain the optimism that it had at the beginning of the year.
  • Notably, the 10% baseline tariffs may be more negotiable than the Trump administration’s public position indicates. As we previously reported, President Trump’s chief economic advisor Kevin Hassett has suggested that exceptional trade concessions could justify rates falling below the 10% threshold. Should any trading partner successfully secure such terms, it would represent a significant policy shift.
  • Market expectations have evolved significantly — where investors once demanded complete tariff elimination, they now view moderated tariffs as an acceptable outcome. This shift suggests cautious optimism that the Trump administration can balance its dual objectives of generating tariff revenue without the market disruption.

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Daily Comment (April 15, 2025)

Posted on by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with developments in the global auto and oil industries, largely reflecting the Trump administration’s new US tariff policies. We next review several other international and US developments with the potential to affect the financial markets today, including a Chinese retaliatory strategy that will crimp US access to critical minerals and magnets and a review of a key Federal Reserve board member’s speech in St. Louis yesterday.

Global Auto Industry: President Trump yesterday acknowledged that auto and auto parts makers will “need a little bit of time” before they can boost production in the US, adding that, “I’m looking at something to help some of the car companies.” The statement raised hopes that the administration will provide tariff relief on autos and parts or perhaps offer some other kind of aid. In response, global automakers are enjoying big gains in their share prices so far today.

  • It’s not clear how Trump could have failed to realize the time and cost it would take for automakers to adjust to his tariff policy and shift production to the US.
  • Nevertheless, Trump’s statement will likely be taken as a welcome sign of flexibility in his policy approach. This will raise hopes that he may soften his policy or implement it more gradually going forward, not just for automakers but for other key industries.

Global Energy Industry: In its latest report on the oil market, the International Energy Agency slashed its forecast of demand growth this year by about one-third to just 730,000 million barrels per day. According to the agency, the smaller figure largely reflects weakening demand in the US and China as those countries impose disruptive tariffs on each other. Faltering demand growth and increased production by key suppliers is likely to keep weighing on global oil prices in the near term, with Brent today down some 0.8% to $64.41 per barrel.

Global Defense Industry: Even though President Trump has issued orders aimed at boosting the US shipbuilding industry and accelerating the construction of ships for the US Navy, he said in a statement last week that he may ask Congress for authority to buy future navy ships from foreign countries in the interim. It appears that the most likely foreign suppliers of navy ships would be Japan and South Korea.

  • As we have often noted, questions about Trump’s commitment to US allies have already prompted key countries to accelerate their defense rebuilding. We think that has created investment opportunities, especially in European defense stocks.
  • It would probably take some time for the US to significantly boost its orders to Japanese or South Korean shipyards. However, given the enormous size of the US defense budget, any such program could be a boon to Asian companies and defense stocks.

China-United States: Amid all the news on the US-China tariff war over the last week, many investors may have missed an equally important new trade barrier. Late last week, Beijing said it is suspending the export of several critical minerals and advanced magnets. Since China has a virtual monopoly on the supply of such products, the move threatens to disrupt the operations of automakers, aerospace manufacturers, semiconductor firms, and military contractors around the world, at least when those companies work through their current inventories.

  • After President Trump announced his “reciprocal” tariffs on April 2, China said one of its retaliatory measures would be to impose licensing requirements for the export of six heavy rare-earth metals, which are refined entirely in China, and rare-earth magnets, 90% of which are produced in China.
  • Chinese officials say the export suspensions are only to allow the government to develop the required licensing procedures. Of course, the risk is that Beijing will slow-walk that process, essentially leaving in place an export ban on the rare earths and magnets.

Japan: New official data released yesterday showed that the Japanese population fell 0.44% to just 123.8 million in 2024, marking the 14th straight year of contraction. In addition, the share of those aged 65 and older hit a record 29.3%. Low birth rates, falling headcounts, and population aging continue to present long-term challenges for the Japanese economy and businesses, even though labor market reforms in recent years have temporarily averted problems by drawing more people into the labor force.

Germany: The ZEW Economic Sentiment Index dived to -14.0 in April, down from 79.6 in March. The reading was much worse than expected. The ZEW indicator tracks the expectations of analysts at German banks, insurance companies, and other firms, and the latest reading likely reflects plummeting confidence in Europe’s largest economy after President Trump announced his big tariff hikes earlier this month.

United States-United Kingdom: Vice President Vance said in an interview yesterday that he sees “a good chance” of the US and the UK striking a free-trade deal “that’s in the interest of both countries.” As a reminder, the Trump administration has only subjected the UK to the president’s baseline tariff of 10% so far. A US-UK trade deal would be a political boon for British Prime Minister Starmer, but some members of the Trump coalition might push back against any concessions to UK manufacturers, especially if they help Starmer’s center-left Labour Party.

US Monetary Policy: At an event in St. Louis attended by Confluence personnel yesterday, Fed board member Christopher Waller discussed how he is thinking about President Trump’s tariff hikes and what they might mean for US monetary policy. Importantly, Waller insisted that higher US import tariffs would only boost consumer price inflation temporarily. However, he stressed that uncertainty surrounding the tariffs could weigh heavily on economic growth, with many firms telling him they have frozen investment and fear going out of business.

  • To guide his thinking about the tariffs, Waller said he is considering two basic scenarios. In his “long lasting, high rate” scenario, Waller envisions average US import tariffs staying at 25% through at least 2027, up from about 3% at year-end 2024. In this scenario, Waller said he would expect inflation to surge to as much as 5%, but only for a short time. He expected that growth in this scenario would slow sharply, potentially setting the stage for multiple interest-rate cuts.
  • In his “temporary, low rate” scenario, Waller assumes the average import tariff would quickly fall back to 10% as the US and other countries negotiate new trade relations. He expects inflation in this scenario to rise to only about 3% and then fall back quickly. In this scenario, Waller suggested the Fed would stand by its current plans to cut rates just a few more times before the end of this year.

US Tariff Policy: Reports yesterday said the Trump administration has opened investigations into the national security implications of relying on foreign semiconductors, semiconductor manufacturing equipment, pharmaceuticals, and pharmaceutical ingredients. The probes are being widely seen as preliminary steps to imposing steep new import tariffs on semiconductors and pharmaceuticals, especially those from China. Those new tariffs could come in the next few months, once the probes are completed.

  • Separately, in a quarterly earnings call, healthcare giant Johnson & Johnson today said it expects as much as $400 million in tariff costs on medical devices this year, counting only the baseline, reciprocal, and other tariffs announced so far.
  • Based on those tariff costs, the company boosted its 2025 sales forecast but kept its earnings expectation unchanged. The forecasted numbers would presumably change if the Trump administration imposes steep tariffs on pharmaceutical imports later this year.

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Daily Comment (April 14, 2025)

Posted on by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Against the backdrop of President Trump’s on-again/off-again policy moves and mixed messages, we think his 90-day pause on non-China “reciprocal” tariffs last week is confirmation that his top target in the trade war is China, as it likely should be. Since that suggests US-China tensions could keep rising, we start our Comment today with a potential “escalation ladder” of future adversarial steps between the US and China that investors should probably be watching for. We next review several other international and US developments with the potential to affect the financial markets today, including new signs of distrust between the US and Europe and a few words on what appears to be capital flight from the US.

US-China Trade War – Escalation Ladder: As noted above, Trump’s tariff moves last week seem to confirm that China is his top target in the trade war. Trump is trying to walk a fine line between rebalancing the US-China trade relationship while not antagonizing China too much. US-China tensions could therefore keep rising in the coming months, creating further investment risks. To show how US-China relations could evolve, we lay out the following potential “escalation ladder” of future steps that each side could take against the other:

  • Restrictions on Goods Trade. Despite China’s statement last week that it won’t match any more US tariff hikes because further hikes would be economically meaningless, the US could keep hiking China’s rates. Both the US and China could also extend their tariffs to currently exempted goods or hike their tariffs on lower-rate products. They could also set non-tariff barriers on imports or exports (such as bans on critical mineral exports). They could even put tariffs on third countries that import from their adversary.
  • Restrictions on Services Trade. Since tariffs are taxes on imported goods, the next step in the trade war could be for the US or China to impose onerous taxes on each other’s services, such as legal advice, consulting, or transport. They could also clamp down on the provision of services. For example, China could increase its ongoing harassment of some US firms providing legal, financial, and consulting services in China. The US might also try to ban its firms from providing such services.
  • Restrictions on Capital Flows. For investors, an especially harmful escalatory move would be for the US to limit capital flows to or from China, and vice versa. For example, Treasury Secretary Bessent last week hinted that the federal government might force Chinese firms to delist from US stock exchanges. Such a move would add to existing restrictions on US investments in Chinese equities. The US or China could also bar its investors from buying their adversaries’ bonds, including Treasurys.
  • Restrictions on Travel and Tourism. Both the US and China have already taken steps to discourage their citizens from visiting their adversary and to harass their adversary’s citizens in country. Further steps could include broadening the US ban on technicians visiting China to service advanced chip-manufacturing equipment. The US or China could also impose outright bans on academic researchers or students visiting one another.
  • Diplomatic Maneuvers. One specialized form of travel restriction could be for the US or China to cut their diplomatic representation in each other’s country or demand a cut in their adversary’s diplomatic corps in country. Each side could also step up their efforts to undermine each other in international forums such as the United Nations.
  • Military Initiatives. Just as Japanese leaders saw US sanctions and oil embargos as an existential threat in 1941, prompting them to attack Pearl Harbor, Chinese leaders facing the whole array of escalatory steps outlined here could potentially decide they must strike back militarily. For example, they could finally seize control of Taiwan. The US could also launch provocative military moves against China to back up its economic pressure. Clearly, such moves would be a worst-case scenario; they are not necessarily probable.

US-China Trade War – Electronics Exemption: In its latest on-again/off-again move on US trade policy, the Trump administration said late Friday that key electronic products would be exempt from its “reciprocal” 125% tariffs on Chinese imports. The exempted goods include desktop computers, laptops, tablets, smartphones, flat-screen televisions, memory chips, and chip-making equipment. However, Trump and his officials yesterday signaled that new tariffs would still be coming on many of those products in the near future.

  • The Friday exemptions may constitute a subtle concession by Trump to encourage positive moves by China. After all, electronics make up the biggest category of Chinese goods sent to the US (smartphones alone account for almost one-tenth of US imports from China). The exemptions may also be aimed at helping US firms dependent on selling China-sourced goods, such as Apple. In response, futures trading currently suggests the US stock market will open on a firm note today.
  • Nevertheless, the US’s remaining 20% tariffs against China will still be an issue, and the Sunday statements pointing to new electronics tariffs in the future will likely keep US-China tensions high. The risk of new tariffs in the future will probably also short-circuit any relief that US firms felt upon hearing of the Friday exemptions.

US-Japan Tariff Talks: Ahead of Thursday’s US-Japan talks on tariffs and trade relations, the policy chief of Japan’s ruling Liberal Democratic Party has offered assurances that his country would not try to use its massive holdings of US Treasury obligations as leverage. The statement signals that Tokyo will try to keep the talks as amicable as possible, raising the prospects for a quick agreement that isn’t overly disruptive for the Japanese economy and financial markets.

  • Despite Tokyo’s assurances about US Treasurys, it is becoming increasingly clear that a key US economic risk from Trump’s trade policy may relate to financial flows rather than trade flows. The evidence in this regard is the fact that the market volatility touched off by the trade war hasn’t spawned the usual safe-haven buying in the US dollar and Treasury securities. Instead, the greenback has depreciated sharply, Treasury prices have fallen, and US bond yields have jumped.
  • The decline in the dollar and Treasurys, along with falling values for US stocks and other risk assets, suggests that the dramatic changes in US trade and economic policies and the administration’s adversarial approach to foreign countries have undermined faith in the US as an investment destination. That could merely reflect near-term concerns about a US recession. However, if these trends continue, they could mean that the US has become more fundamentally tarnished and that what we’re seeing is capital flight.
  • Capital flight could weigh on the US domestic economy in a couple of important ways. For one thing, Treasury dumping by foreign countries, central banks, or private institutions could push US interest rates so high as to impede investment and economic growth. At the same time, the falling dollar would likely further raise the price of imports, weighing on consumption and pushing up inflation.

Taiwan: The ruling Democratic People’s Party is reportedly mulling the launch of recall campaigns against opposition lawmakers with the relatively China-friendly Kuomintang party. The KMT has only 52 of the 113 seats in the legislature, but with six allies from the Taiwan People’s Party and two independents, it has been able to form an opposing majority to paralyze the DPP’s legislative initiatives. One key risk is that a DPP recall initiative could worsen political polarization on the island and shift support toward the KMT.

Ecuador: In elections yesterday, conservative President Daniel Noboa was re-elected to a new four-year term with approximately 56% of the vote. The loser was Luisa González, a protégé of leftist former President Rafael Correa. Now that he has a full term in office, Noboa is expected to continue his tough crackdown on violent drug gangs and keep building ties with the US.

European Union-United States: In the latest sign of falling trust between the US and the EU, the European Commission has reportedly begun issuing burner phones to US-bound officials to avoid US espionage. The measure replicates steps taken for EU officials traveling to Ukraine and China to avoid Russian or Chinese surveillance. The measure also illustrates the extent to which US-EU trust has fallen, which could derail any future efforts by the two sides to cooperate in security, trade, or finance.

United States-Iran: US envoy Steve Witkoff and Iranian Foreign Minister Abbas Araghchi met in Oman on Saturday to start talks aimed at preventing Iran from acquiring nuclear weapons. The US and Iran had both insisted that the initial talks were merely aimed at gauging whether the other side was serious about an agreement. Early reports suggest both sides saw the other as serious, so follow-on talks are scheduled for next Saturday.

US Fiscal Policy: “First Buddy” Elon Musk reportedly said in a Cabinet meeting last week that his Department of Government Efficiency would fail to reach its goal of cutting $1 trillion in federal spending in the current fiscal year, which ends September 30. Instead, Musk said DOGE would cut about $150 billion in outlays, and outside analysis suggests even that figure is inflated by errors and miscounts.

  • DOGE’s failure to achieve greater spending cuts could make it harder for President Trump to get Congressional approval for the upcoming year’s budget, which includes extensions to his 2017 tax cuts.
  • Given the political and administrative challenges to cutting outlays significantly, Trump’s extended tax cuts could well lead to even bigger budget deficits. With global investors now increasingly wary about investing in the US, that could prompt even weaker demand for Treasury securities and a further backup in yields.

US Consumer Spending: In a little-noticed statement in its first-quarter earnings report, JPMorgan said the portion of loans in its credit card business deemed unrecoverable has now risen to a 13-year high. The statement is consistent with other incoming reports that suggest charge-offs in the overall credit card industry are now higher than they were before the coronavirus pandemic. The data adds to the current worries that consumers may be ready to rein in their spending, which would slow economic growth and reduce corporate earnings.

US Commercial Real Estate Industry: According to data provider CoStar, a tentative rebound in office demand that saw leasing activity jump 13% in the first quarter is already cooling in response to the uncertainties of the administration’s trade war. Office-building sales and refinancings have also reportedly slowed after a short-lived rebound. A new downturn in the market would not only weigh on stocks directly related to office buildings, such as real estate investment trusts, but it would also keep alive risks to the broader financial system.

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Asset Allocation Bi-Weekly – From Magnificent 7 to European Revival (April 14, 2025)

Posted on by Amanda Ahne

by Thomas Wash | PDF

European equities have long suffered from investor skepticism and been burdened by perceptions of excessive regulation, bureaucratic inertia, and elevated operating costs. These structural challenges have historically overshadowed the region’s fundamental strengths. Yet 2025 has marked a striking reversal, with European stocks delivering exceptional returns that have handily surpassed US market performance.

Much of Europe’s recent outperformance relative to the US can be traced to the unwinding of the “Trump trade,” which began in the weeks following Donald Trump’s victory in the November 2024 election. During this time, markets seemed to embrace the narrative that his policies — deep tax cuts, aggressive deregulation, and a pro-growth agenda — would cement US economic dominance. While tariffs were always a part of the equation, investors initially expected them to be used selectively rather than aggressively.

While US equities surged after the November election, European stocks languished as investors anticipated a widening growth divide. The eurozone has now gone seven consecutive quarters without achieving 2% annualized growth in its gross domestic product, a streak dating back to the third quarter of 2022. Nowhere were these struggles more apparent than in Germany, where the industrial sector — traditionally the Continent’s economic powerhouse — became its biggest drag.

Market expectations shifted abruptly in the Trump administration’s early weeks as it simultaneously challenged existing trade arrangements and demanded greater military spending from allies. The tariff threats created immediate uncertainty as businesses shelved investment plans and consumers braced for inflationary pressures. Meanwhile, growing doubts about US security commitments prompted EU leaders to accelerate plans for strategic autonomy.

We think the rotation from US to European equities was primarily valuation-driven, with the US’s once-dominant Magnificent 7 declining as investors shifted from growth to value. This marked a dramatic reversal from previous years when tech-heavy growth stocks consistently outperformed. European markets, with their heavier weighting in value sectors and more attractive price-to-earnings ratios, became natural beneficiaries of this change in investor preference.

While capital rotation remains modest to date, escalating trade tensions may accelerate foreign divestment from US assets in favor of European markets. These geopolitical strains have triggered a broad risk-off shift among investors, with capital flowing toward value assets rather than growth equities. This reallocation reflects a fundamental reassessment of global trade dynamics as nations increasingly recognize that traditional US trade relationships may be changing for good.

This shifting sentiment marks a potential inflection point after years of sustained US equity outperformance. For decades, global investors have disproportionately favored US markets, having been lured by three key advantages: (1) superior growth prospects, particularly in the technology sector; (2) unrivaled market depth and liquidity; and (3) the structural strength of the dollar. These factors became particularly pronounced in the post-pandemic era when the greenback’s appreciation created an additional return tailwind for foreign investors.

In an especially important development during this period, the US began running deficits in both its trade balance and its “primary income” balance. This twin deficit was problematic because it signaled that foreign investors were earning higher returns on their US investments than what US residents were earning abroad. In other words, the US was not only importing more than it exported but also paying out more in interest and dividends to the rest of the world than it was receiving.

The growing imbalance stemmed from two key factors: persistent US equity outperformance relative to global markets and the Fed’s rate hikes that made Treasurys more attractive to foreign investors. These forces converged in the Net International Investment Position, resulting in the value of foreign-held US assets eclipsing America’s cumulative trade deficit for the first time ever. The shift reflected both a reversal from direct investment surplus to deficit and rising portfolio investment values — twin manifestations of superior US asset returns.

Typically, such conditions would prove problematic for most economies as they could trigger disproportionate currency outflows and subsequent depreciation or make its markets vulnerable to panics. However, the US dollar’s unique status as the global reserve currency and its deep and open capital markets have largely shielded it from these adverse effects.

Nevertheless, significant risks remain. US equity markets could experience heightened volatility should foreign investor sentiment deteriorate, with the technology sector being particularly vulnerable due to its elevated valuations. The scale of this exposure is evident in foreign holdings, which now compose over 30% of US equities, driven by a dramatic surge in both portfolio income and direct investment flows.

A sudden erosion of confidence in US equities could precipitate a significant capital rotation into foreign equities and gold. Europe appears particularly well-positioned to benefit from this shift, owing to its relative valuation discount and potential for capital repatriation flows. Within the region, Germany stands out as especially attractive given its increased defense spending commitments. Meanwhile, gold could emerge as the safe-haven asset of choice, with the potential to displace US Treasurys as a reserve asset over time.

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Daily Comment (April 11, 2025)

Posted on by Amanda Ahne

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets are closely tracking the latest trade developments. In sports, Alex Ovechkin has cemented his legacy as the NHL’s all-time leading goal scorer. Today’s Comment will explore why the bond market continues to shrug off inflation data, provide an update on the Trump tax bill, and discuss the EU’s escalating regulatory push against Big Tech. We’ll also cover other market-moving news and, as always, provide a roundup of key international and domestic data releases.

Bond Market Turmoil: In a telling sign of shifting market priorities, bond investors largely dismissed the better-than-expected inflation data.

  • The Consumer Price Index (CPI) fell in March for the first time in nearly five years, suggesting that recent tariffs have not yet translated into higher consumer prices. The index dipped 0.1% month-over-month, defying economists’ expectations of a 0.1% increase. Even the core CPI, which excludes volatile food and energy costs, inched up just 0.1%, well below the projected 0.3% rise. The moderation in inflation was driven largely by falling gasoline and used car prices.
  • While the slowdown in the CPI report was welcomed, the exact drivers of the decline remain unclear. Weak demand — likely tied to broader economic concerns — appears to have weighed heavily on gasoline prices and airline fares, which fell 6.3% and 5.3%, respectively. Meanwhile, shelter cost, the index’s largest component, grew at its slowest pace since June of last year. The moderation in shelter costs suggests that the post-pandemic price distortions are gradually working their way through the economy.
  • While cooling inflation has traditionally been welcomed by markets, investors are growing increasingly concerned about persistent price pressures due to tariffs. Retailers are now warning of potential price hikes as rising costs and lower inventories squeeze margins. These increases could emerge across various sectors, from imported fruits (with the US importing roughly 65% of its supply) to bicycles (which rely heavily on foreign components).

  • Corporations appear to be ready to test their pricing power, with firms passing input costs on to consumers. While this worked early in the business cycle, it is unclear if it will be effective in the current environment. Lower-income households, while initially protected by pandemic-era savings and wage growth, now face diminishing financial cushions. Simultaneously, equity market declines threaten to suppress consumption via the wealth effect among affluent demographics. As a result, firms may face resistance.
  • While stagflation cannot be ruled out entirely, it’s important to note this phenomenon typically occurs during severe energy shocks. In fact, before the 1970s, most economists considered stagflation theoretically impossible. That said, given the unexpected resilience of households in weathering inflation so far, we can’t dismiss the possibility completely. Currently, the bond market appears to be establishing a new equilibrium, a process that may temporarily impair its traditional role as an economic indicator.

Fiscal Deficit Widens: As Republicans move closer to passing tax cuts, growing concerns emerge that investors may become wary of holding debt due to the rising deficit and uncertainty about future economic growth.

  • House Republicans advanced their budget blueprint, 216-214, targeting extensions of Trump-era tax cuts and deeper spending reductions. The close vote, which relied on almost complete GOP support, revealed the party’s narrow majority. Lawmakers touted potential long-term savings of $1.5 trillion, but the bill only specifies $4 billion in cuts over the next decade, demonstrating a substantial discrepancy between their stated fiscal goals and the immediate impact of the legislation.
  • Despite some fluctuations, the US deficit remains a significant concern. The federal government reported a $1.307 trillion shortfall for the first half of the fiscal year (October-March), marking the second-largest six-month deficit on record. This figure is close to the unprecedented $1.706 trillion deficit seen during the same period in 2021, when pandemic-related expenditures were at their highest.

  • Luckily, investor appetite for long-term bonds in the primary market remains resilient in the face of headwinds. Thursday’s $22 billion, 30-year Treasury auction saw robust demand, with the debt clearing at 4.435%, below the expected yield at the bid deadline. This strong showing follows Wednesday’s solid 10-year Treasury auction, suggesting investor concerns about tariffs dampening demand for US debt may be overstated.
  • While concerns persist about the recent rise in 10-year Treasury yields, there are no clear indicators this represents a crisis. The upward movement appears primarily driven by investors raising cash through position liquidations, though market speculation points to possible foreign central bank selling — the People’s Bank of China being the most probable candidate. Should this yield momentum continue, Federal Reserve intervention may become increasingly likely.

EU Prepares for US Talks: The EU is prepared to protect its interests as it seeks to meet the US halfway in some of its demands.

  • European Commission President Ursula von der Leyen is set to negotiate with the US during a 90-day window. However, she has warned that the EU is prepared to walk away if talks are not conducted in good faith and potentially retaliate by targeting US trade in services, specifically tech firms, with digital taxes. Her threat follows US efforts to address the EU trade imbalance and scrutinize its tax policies.
  • Her remarks follow the Trump administration’s criticism of the EU, targeting not only its trade surplus with the US but also its defense spending, tax policies, and regulatory framework. While the European Union has shown a willingness to discuss military expenditure and trade issues, it has remained silent on addressing other American concerns such as getting rid of VAT or loosening tech regulation.
  • The current standoff between the US and EU will likely center on establishing a mutually beneficial framework for cooperation. The most probable outcome would involve creating an economic ecosystem that simultaneously limits China’s influence while advancing Western technological ambitions. Given these strategic imperatives, we believe negotiations could still foster closer transatlantic ties, provided both sides demonstrate a willingness to make concessions for a meaningful agreement.

End to Tariff Madness? China has retaliated against the US decision to impose 145% tariffs on its goods by introducing 125% tariffs on American products. However, Beijing has indicated it does not intend to escalate tariffs further.

  • China’s move to raise tariffs on US goods signals its readiness to withstand a prolonged trade conflict with Washington. While Beijing has pledged to avoid further tit-for-tat measures, it has firmly stated it will not back down. These tensions underscore the accelerating economic decoupling between the world’s two largest economies.
  • These escalating tariffs have now reached levels that make cross-border commerce commercially unviable for many firms. This development threatens corporate earnings in both nations, as US companies have depended on China’s rapidly growing consumer market for overseas profits, while Chinese firms have relied on access to America’s massive consumer base.

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