February 2025 Market Strategy
There is no doubt about it anymore, the recent deficit acceleration has finally reached the CPI. Whether that will trigger a larger reflation story depends on whether the fiscal cliff materializes.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
In my January 2025 Market Strategy, I argued that the inflation flare will likely be short lived because its main driver - the most recent deficit acceleration - will likely prove short lived. This may send interest rates down more than most people expect which may coincide with a fiscal cliff and a risk-off impulse. US assets would be most vulnerable in such a scenario.
Let’s check how the picture has evolved since then.
TLDR Summary
The January 2025 CPI print was the first proper reflation scare. Both headline and core advanced at rates way beyond the Fed’s 2% target. The major culprit for this is clear: the Treasury’s deficit. On a FY25tD basis, it currently stands at $786bn, $274bn (!) higher than at the same point last year. Before the latest fiscal impulse started in October 2024, the deficit was trending flat year-over-year. Earlier in 2024, we were trending down at a rate of up to $200bn annually.
Hundreds of billions of dollars more than expected have been fed into the economy over the last few months. That has consequences for the prices for goods, services and assets which we are witnessing right now. The latest CPI print is merely a glance in the rearview mirror. The key question is whether that will continue. There are strong arguments against that. However, we still have to wait to actually see them unfold.
Investors have made up their mind already. There is pretty much no concern about a possible fiscal cliff. It doesn’t show up anywhere in the latest Bank of America Global Fund Manager Survey! The consensus macro read is that this is simply a robust US economy fueled by American exceptionalism and the AI innovation theme. Cash is hated like never before in the history of this survey. And stocks, most importantly US stocks, are loved with passion. I still believe that the odds favor a crude awakening for this consensus.
Beyond this primary macro theme, there is a curious second layer unfolding: the potential resurrection of the Eurozone, at least from an investor perspective. The real Trump trade might be long Europe, short US. The Ukraine war crushed the Eurozone. It forced them to buy gas from overseas for 4x the cost of Russian gas. And it provided a huge market opportunity US defense companies to provide the ammo and equipment for the meat grinder. If Trump finally ends this war, Europe (and Germany in particular) may soon be buying Russian again. It will instantly make a ton of industries competitive again. Markets seem to be frontrunning this already. Europe has been outperforming big YTD. If my case for an underperformance of US stocks with a weaker US Dollar needs a catalyst, this one may be it.