Crypto News: 'Tariff Man' has unanchored inflation expectations

It seems to be almost quaint to talk about financial markets when the US President is talking about making Gaza "the Riviera of the Middle East" under US "ownership" — a move categorically rejected by American friends and foes alike — and unleashing administrative chaos across Washington. But Donald Trump is also upending financial markets by ordering up tariffs on Mexico and Canada — and then temporarily delaying them just as they were set to begin. It's made it difficult for businesses and consumers to know what's coming. But the the specter of trade-war induced price hikes has already caused inflation expectations to rise — a worrisome development that could have significant implications for bonds and equities across the globe.

We're only a few weeks into this new administration. So it's too early to make any definitive conclusions about its overall future impact on markets. But it's clear we are now beset with unpredictability on all fronts, including inflation. And that will raise the cost of everything from the cost of goods and services to the cost of holding long-dated assets. The only question is whether that can be offset by growth. I don't think it can. So downside risk prevails, which is bullish for Treasuries, but bearish for equities, especially growth stocks.

Let's look at this working forward from the conclusions we drew last week:

Last week's piece basically said forget about the Fed and focus on Trump and AI. I think the events since then reinforce that view.
While the focus then was more on AI, given the volatility induced by the success of AI chatbot DeepSeek, the ensuing week should turn our attention to Trump and what he means for markets.
What we've learned is that his policies are shape-shifting and ever-changing. The result for the markets has been increased worries about inflation coupled with — and maybe partially offset by -- increased worries about slowing growth or recession.
To date, the fears have largely been reflected in the bond market while the equity bull market hasn't been broken — reflecting more optimistic expectations for growth. Only one can be right, and I lean heavily toward the bond market being a warning bell that will eventually herald a change in the equity market's sentiment, too.

Trumponomics is bad for inflation?

By the way, this is short notice but let me add that I'll be a guest on a live taping of the Trumponomics podcast Bloomberg's New York headquarters. If you're in the area, join us in person for a discussion of global economics in the Trump era. More information here.

As for Trumponomics, his second administration is probably the cleanest break from past American domestic, foreign and economic policy any of us have seen in our lifetimes. The unpredictability is something Trump relishes as a sort of secret weapon that he believes strengthens his negotiating hand. But it makes planning for businesses and market analysts a lot harder.

Over the weekend, we saw the Trump Administration start to make good on its threats to put tariffs on goods from Mexico, Canada and China. All three countries promised retaliation. But on Monday, as the tariffs were set to go into place, Mexico and Canada each got a one-month reprieve. Equity markets sold off on the initial news and then clawed back some of their losses. US government bonds rallied as a safe haven bid but only for longer-maturity Treasuries. Tellingly, maturities out to two years sold off on inflation worries, with their yields remaining elevated even after the tariffs on Canada and Mexico had been stayed.

So what conclusion can we draw from this first big Trump economic policy salvo? I would say the shock from the tariff drama has raised near- and medium-term inflation risk. If you remove slowdown and recession risk by just focusing on inflation expectations embedded in inflation-protected Treasuries (TIPS), you see that. The breakeven for two years -- the difference in yield of the two-year maturity variant of TIPS and normal two-year Treasuries, which measures those inflation expectations -- topped 3% for the first time in two years. That is to say, even though the Fed's official measure of inflation is 2.8% and the Fed's inflation target is 2%, the bond market expects inflation to be 3% over the next two years.

In essence, traders are signaling that Trump's policies are bad for inflation.

What does the Fed do?

The telling statement about what's happening here is Donald Trump's reaction to the Fed's latest hold on rate policy — which came before the recent tariff imbroglio. He says they did the right thing by not cutting rates.

"I'm not surprised," Trump told reporters upon arriving in Washington on Sunday evening. "Holding the rates at this point was the right thing to do."

It's as if he's signaling his policies are going to be inflationary and that he no longer expects or is going to insist the Fed start cutting rates unless US economic growth falls. Lo and behold we got tariffs a few days later, the ones on China actually taking effect. And even after weak economic data since then from the survey on jobs openings and the ISM services sector survey that caused yields to plummet, those market-based inflation expectations for two years remain firm at 3%.

What does the Fed do with this new information? Well, the bond market is saying the Fed cuts anyway, with a cut fully priced in for June and almost fully priced by May. But that's entirely about the risk of slowing growth. In December, the Fed projected inflation would fall to 2.5% by the end of this year, on its way to 2% by the end of 2027. That would allow them to cut rates by a half percentage point this year. The risk, especially if growth doesn't slow and inflation and inflation expectations remain high, is that the Fed doesn't cut at all. And so, as 2025 proceeds, recession risk could mount.

To sum up then, Trump has caused market-based inflation expectations to rise to 3%, inline with consumer expectations in surveys like the University of Michigan's. But this hasn't hurt the bond market because the risk of growth slowing has also risen with Trump. Bond yields have fallen as a result. If the Fed cuts, it would only be to ward off a recession as the palpable risk of stagflation has now increased markedly. That's problematic for equities.

By the numbers

3.2%

- Consumers' current expectation for inflation over the next 5 to 10 years according to the University of Michigan Consumer Sentiment Survey due out again on February 7th

This now all hinges on the Magnificent Seven

For the equity bull market to continue, a very narrow segment of companies needs to continue to perform well even as this stagflation risk creeps in.

In 2023, only 27% of stocks outperformed the S&P 500 Index, making it the narrowest market since at least 1995. The trend continued in 2024, with just 28% of stocks beating the index
-First Trust Economics, Jan 8, 2025

Another way of saying that less than 30% of stocks outperformed the index is saying that 70% underperformed. Why are we seeing this incredibly narrow but large rally? In two words: Artificial Intelligence.

When ChatGPT got onto investors' radar screen, the Fed rate hike-induced swoon in equities ended. And the biggest technology companies, all of whom have significant ties to AI, dominated the market's gains, especially Nvidia. In 2023, these so-called Magnificent Seven stocks were responsible for almost two-thirds of the S&P 500's market capitalization gain. In 2024, the rally broadened somewhat but the Mag 7 still accounted for more than half of the S&P 500's gains. That effectively means either this rally broadens or we need these companies to continue to outperform.

AI firms are taking on water as a bulwark for markets

In the most recent earnings results from big tech, Google's corporate parent Alphabet just showed its boosting capital expenditure to $75 billion in 2025 despite an underwhelming performance in its cloud computing unit underpinning that capex. But the fact that both Microsoft and Google have shown weaknesses there indicates the time is approaching when the near limitless spending on AI will come to an end.

At Tesla, another Mag 7 company, the results were even worse. They missed on timeline revenue and on income and their guidance was lower than expected. Tesla's stock price rose anyway:

The electric-vehicle maker's fourth-quarter earnings fell short of analysts' expectations pretty much across the board. Profit, revenue and margins all missed. Even its sales growth outlook for 2025 was dialed back. Yet, the stock closed up 2.9% on Thursday, as investors shrugged off the disappointing report and instead focused on Musk's upbeat tone on the robotaxi business, humanoid robots and artificial intelligence.

Maybe this has to do with Elon Musk's proximity to Trump. Maybe it's pure irrational exuberance by Tesla's investors. It doesn't matter. Either way it's in line with what we see elsewhere at some of the world's leading tech companies: even before the stagflationary risks from Trump come to play, slowing growth is evident. The Google and Meta results show that the thing that is holding up best for the Mag 7 is advertising. And because ad spending is cyclical, slowing economic growth is a threat to those firms' bottom line — and by extension their share prices and the overall health of this bull market.

Nvidia's earnings is where the rubber hits the road this quarter yet again. That won't come until almost the end of February, right when we find out whether the Mexico and Canada tariff delay will be extended or will hit this time.

Expect bonds to move first

To sum, while the Trump-induced real economy risks are ongoing, we are seeing slowing growth in the Mag 7 stocks that have underpinned the bull market for two years. That has led the market to trade sideways for the better part of two months. I don't expect market angst about their growth to lead to anything dramatic in the near-term simply because capital expenditure plans are set in stone in that timeframe, as earnings from Google, Microsoft and Meta all show. And therefore I don't expect Nvidia's earnings release to be a negative catalyst for the market either.

Instead I expect bonds to be the canary in the coal mine. On Wednesday, immediately following a weak report that is widely foll0wed on the services sector from the Institute for Supply Management (ISM), we saw 30-year bond yields drop 10 basis points to 4.64%. That put them a third of a percentage point lower than January 14th, before Trump took office, the best sign we have that a flight to safety due to fear around the geopolitical and economic environment is outweighing the inflation risk. Where last week I thought upside surprises on economic data and inflation could drive this long bond's yield to 5%, I now think we can go lower as the uncertainty mounts.

What that means for investors is threefold:

You can probably start to lengthen maturity. The risks of higher yields from inflation and growth have lessened so much relative to the risk of slowing growth and recession that you're going to want to lock in yields. How far out depends on your inflation risk tolerance.
Those trades a lot of bond investors have been making, anticipating a further increase in long-maturity bond yields relative to shorter-maturity ones as the economy continues to grow, won't work. Suddenly we are in a place where people want safe assets and risk will get shunned.
Where the threat to equities in the higher growth pre-Trump environment came from the higher yields demanded from the risk of higher inflation, in today's environment it's about this cycle's endgame with the popping of the AI bubble, something that isn't imminent just yet.

I haven't mentioned the word crisis just yet but...

In reviewing what I just told you, I recognize none of this is terrible for investors. A few weeks ago, I had gone from being bullish on equities because there was economic growth as far as the eyes could see to a bit more bearish than bullish. And while today's piece doesn't seem to be a marked change in viewpoint, it is. In the back of my mind is the sense that this bull market and economic cycle ends in crisis, not a garden variety recession.

I've been thinking a lot about the assumptions embedded into a chart like the one Deutsche Bank made in late January on Nvidia's earnings expectations.

And the conclusion I've come to is those assumptions are bonkers. Here's a company with a long corporate track record and earnings history, that due to a single theme, AI, is expected to have what looks like limitless growth potential for a decade to come.

Look at that chart. It's only in 2024 that the numbers start upward. So one year. And yet, we're supposed to believe that this fantastic trajectory will continue to the tune of tripling Nvidia's earnings in 10 years? That's a bubble. And bubbles pop. I was at Yahoo when the last bubble popped in the early 2000s. All of the discounted cash flow models I wrote for the company showed that when you take expectations of 30% growth a year and turn them into a 20% decline in a single year, followed by stagnation or slow growth, it doesn't just hurt valuation. It crushes it. 80, 90% declines. This is what awaits us.

You could make the argument that this is just one company. But it's not. It's the tip of the spear. Nvidia is simply the one company most emblematic of the whole investment climate we live in from the Mag 7 to crypto to private markets. It's all predicated on growth. And we'll keep dancing as long as there's growth. As Chuck Prince then-CEO of Citigroup put it in July 2007 though, "when the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."