Observations by David Robertson, 7/18/25

The noise to signal ratio of news the last few weeks has been hitting more highs than the stock market! Let’s take a look at what’s going on.

As always, if you want to follow up on anything in more detail, just let me know at drobertson@areteam.com.

Market observations

The large dose of economic news this week started with the consumer price index which came in about as expected but definitely marked an uptick in the medium-term trend. It certainly appears as if tariffs are showing up in prices and inflation is turning higher again. At very least, there are enough smoldering embers of inflation to make cutting rates a serious challenge at this point. This was backed up by a fairly strong retail sales report on Thursday.

One of the key drivers of markets has been attenuated bond volatility. As apparent in the graph from John Authers, the MOVE index is at the lowest level in the last year and a half. This is happening despite data showing inflation is ticking back up and bond yields that are hitting their high marks of the year. Something’s gotta give.

Politics and public policy I

Monopoly Round-Up: Jeff Epstein, MAGA, and Monopolies ($)

https://www.thebignewsletter.com/p/monopoly-round-up-jeff-epstein-maga

Over the last twenty years, a larger-than-life myth has floated around the American political scene, that of Jeff Epstein, a wealthy New York City-based sex trafficker with a murky job and deep connections to some of the most powerful men in America, England, and Israel. Continual revelations around Epstein have fueled MAGA suspicion of big media, big tech, and big government, fostering a mini-ecosystem of Donald Trump-supportive podcasters and influencers. Trump would, they posited, finally expose a Deep State conspiracy, the center of which was this man, Epstein.

Last week, however, Trump did something I thought was impossible - he managed to turn his own core supporters against him. He did so by denying that there is anything conspiratorial or hidden about Epstein’s life or the circumstances of his death.

But to organizers on the right, the Epstein conspiracy meant something different - a business opportunity. Over the course of the 2020s, a network of podcasters, from Dan Bongino to Kash Patel, built up an argument about the Democrats as the protectors of a billionaire and deep state class of pedophiles. These people made a lot of money and became famous on the backs of the story.

The most interesting and arguably most enlightening description of the whole Epstein saga comes from the expert on antitrust issues, Matt Stoller. His main claim is the Epstein issue is not going away. He believes this to be the case not because of any pushback on moral grounds, but rather because of pushback on economic and quasi-religious grounds.

According to Stoller’s theory, a core group of “MAGA supporters need a giant spider web of myths to believe, in order to explain a world that is deeply unfair”. These myths and conspiracies serve as their religion in a way.

While there is certainly a mysterious tale about Epstein himself, the whole situation also created an unusual business opportunity in propagating myths and conspiracy theories about him to people that have an overarching demand to hear them. In short, the Epstein story “powered a rich ecosystem of talkers and sales people pushing supplements and gold to old people”.

By failing to appreciate the psychic need for such stories and the power of the business ecosystem built around them, Trump managed to do something even most of his opponents thought virtually impossible: Lose support of a core MAGA constituency:

He [Trump] chose to do the single worst thing for the MAGA movement, he tried to take away their ability to believe in a moral universe in which they were the heroic army fighting for truth and justice. He also chose to embarrass the podcasting and MAGA influencers who built their businesses on elaborate stories around Jeff Epstein and the Deep State. You can’t just tell them to stop. Too much money and too much belief is riding on it.

I find Stoller’s thesis to be fascinating. If he’s right, this isn’t going away.

Geopolitics

As new tariff proclamations rolled out in Trump’s “letters”, markets are almost completely discounting any potential impact. While this makes some sense on the basis of Trump’s tariff record to date, it overlooks the likelihood that the tariff threats are part of a broader effort.

This “broader effort” is something I mentioned back in January:

Economic statecraft uses economic means for foreign policy/national security goals [as opposed to purely for economic goals], e.g., to force a state to cease hostilities with a third party, open its markets, or act in a certain manner.

I also noted that economic statecraft helps explain the “What” and the “Why” of policy decisions like tariffs. This framework suggests tariffs are being used to force negotiations, but the negotiations are about bigger issues than just trade. Most likely, they are ultimately about firming up geopolitical resistance to China.

This theory is borne out in work by Paul Krugman. He highlights the examples of South Korea and Japan. In both cases, there is very little for either to concede because South Korea has a free trade agreement and Japan has low tariffs and Most Favored Nation status. In addition, the letter Trump sent didn’t specify any problems to address. In short, the tariff threats aren’t mainly about trade.

How are countries like Japan and South Korea likely to respond? Certainly, they will need to compare the pros and cons of their relationship with the US. They will also probably have to make some kind of assessment as to how much national sacrifice should be accepted to maintain that relationship. However, as Krugman highlights, any concession must also be considered in the context of uncertainty as to whether any “deal” would be honored:

The point is that Trump doesn’t feel bound by trade deals America has made in the past. Why should anyone expect him to honor any new deals he makes, or claims to make, now?

At very least, this logic makes the case that most countries should not fully comply with Trump’s demands. In addition, it implies all kinds of work-arounds such as making a superficial deal, failing to completely honor the agreement, slow-walking commitments, etc.

Perhaps Scott Bessent’s trip to Japan this week will reveal some more clues. In the meantime, however, the most likely impact of these negotiations is to further increase geopolitical tensions and to stymie global economic growth.

China

While most of the media attention has been on China’s “beat” of it’s 5.1% GDP estimate, long-time readers will know this contains virtually no information content. In China, the GDP target is set first, and then the necessary resources are deployed in order to achieve it. It is not a report card.

What is a lot more interesting are some of the less publicized reports. For example, Alexander Stahel posts:

China's power consumption in 2025 is running 3.75% below 2024 levels so far—a stark indicator of the country's economic malaise. It speaks volumes about the weak underlying demand in an economy that lacks the flexibility to adjust freely to downturns. China remains stuck in a balance sheet recession, much like Japan in the 1990s.

In addition, other deflationary pressures are appearing as Shannon Brandao ($) reports:

Producer prices in June dropped 3.6%—the sharpest fall in nearly two years—driven by slumping exports and brutal price wars in overbuilt sectors like solar, EVs, and consumer electronics.

With global demand weakening, Chinese firms are undercutting each other in a race to survive.

The result is a self-destructive cycle that even Beijing now acknowledges. Xi Jinping has warned against “involution”—a slang term for economic cannibalism—now adopted in official discourse to describe China’s hypercompetitive stagnation.

The pattern that is emerging is geopolitical backlash is increasing as the tolerance of China’s trade partners to continue absorbing its manufacturing surpluses decreases. This is driving those manufacturers to dump surpluses on China’s domestic market by means of intense price competition.

As Bob Elliott ($) highlights, however, these pressures aren’t sufficient cause China’s economy to spiral out of control:

The result is the Chinese economy is stuck in a bit of a limbo. Not quite weak enough to force the type of big stimulus seen in 08 and post covid, but not quite strong enough to be an engine driving global growth. Stable malaise remains the policy objective and reality.

While he predicts “the Chinese stable malaise is with us for the foreseeable future”, he also recognizes, “A big reason for the stability is from the ability to shift trade away from the US toward other Asian partners and Europe”. If and when that ability to shift trade away diminishes or vanishes, Beijing will be forced to become more proactive.

Japan

How Japan misread Trump 2.0 ($)

https://www.ft.com/content/009d0c7b-d1bf-4bfa-b4a9-f36c9ecc51d4

But suddenly, there are signs of a more fundamental fragility. Trump’s hard-headed approach and Japan’s failure to adapt to it present a rising risk, say senior officials on both sides, of a destabilising conflation of security, trade and currency issues.

Others talk of an unusually severe mutual misjudgment and a widening trust deficit. Wendy Cutler, vice-president of the Asia Society Policy Institute, says the trade deal Trump struck with Japan in 2019 caused both sides to enter the 2025 talks with too much optimism.

Dozens of current and former officials on both sides have told the FT that the alliance as an institution will survive — but that an era-defining reset is now inevitable, and it will be a litmus test of what it means for anyone to be a friend of the US in 2025.

The FT produced a really nice summary of the geopolitical relationship between Japan and the US and how it is changing under the new Trump administration. In doing so, it also highlights many of the interrelated issues on the geopolitical stage.

For starters, the relationship is changing — and for the worse. What had been a longstanding, symbiotic and agreeable relationship has quickly changed into one that is fraught with mistrust and therefore which now has “potentially serious consequences for trade and regional defence”.

The challenges Japan faces are troublesome. On one hand, it relies on the US for defense. On the other hand, it is becoming increasingly questionable whether the US will be there if needed.

Further, this uncertainty is also arising at a time when Japan has serious problems to contend with domestically. Bond yields are rising to reflect the risk that elections this weekend may force a change in the ruling coalition and result in greater fiscal largesse.

So, Japan (like many other countries) is between a rock and a hard place. It is unlikely it can completely acquiesce to Trump administration demands without putting the country’s economy and financial condition at greater risk. Interestingly, it’s not clear that forcing tariffs on Japan results in a better outcome for the US either. Any harm to Japan will almost certainly blow back in the form of currency depreciation or even higher bond yields.

Investment landscape I

Virtually all of the talk about the Fed, the potential of replacing Jay Powell as chair, and monetary policy in general has been focused on lowering short-term rates. As one of the candidates for Powell’s replacement, Kevin Warsh, highlights in a post from Alexander Stahel, a second monetary policy instrument is “the Central Bank’s balance sheet”. He continues, “If we would run the printing press a little quieter, we could then have lower interest rates.”

This is fascinating context that is getting almost no attention. While Warsh is advocating for lower rates, his primary focus is on reducing the Fed’s balance sheet. This is fascinating because doing so would structurally reduce inflation, but at the expense of cutting off the liquidity that drives markets and increasing the real burden of outstanding debt. It would almost certainly be deflationary.

All this makes one wonder how serious Warsh’s policy position is. Maybe it’s a case of fighting the last battle. It would have absolutely made sense ten to fifteen years ago, but debt and deficits are too high now. Maybe Warsh is just trying to “sell” Trump on the idea of lowering inflation. That could be, but it comes with severe consequences. Maybe it’s part of a broader strategy to put severe pressure on China by increasing the value of the US dollar? Possible, but at great risk to the US.

Despite the myriad uncertainties of such a course for monetary policy, it is fairly clear that enthusiasm for lower short rates is misplaced if they come packaged with a smaller Fed balance sheet. Further, while Warsh’s policy framework has merits in terms of providing a stronger monetary foundation, it doesn’t explain how we get from point A to point B without severe financial disruption.

The key will be demand for US Treasury bonds. If that demand was robust, Bessent wouldn’t have needed to restore the Treasury’s general account by using bills exclusively. Further, as Brad Setser notes in a great thread, “an awful lot [of foreign demand] is coming from foreign financial centers (basis traders/ swap speak arbs etc) not real money” and there is no sign yet of a “resurgence in central bank demand for Treasuries” even with a weaker US dollar.

In short, any plan for the Fed to reduce its holdings of Treasury bonds will require an incremental buyer. Currently, it looks like that will not come from foreign buyers. Further, domestic demand is also weak and is likely to be further challenged as debt levels continue to rise. Regulation changes will probably increase demand a bit, but there is already pressure on bond yields. If the Fed reduces its holdings that would only put more pressure on them.

Investment landscape II

One of the foundational rationales for private equity is that illiquid assets generate higher returns (due to the illiquidity premium) and therefore are excellent choices for long-term investors who are willing and able to ride out the long-term. This was the heart of David Swensen’s approach at the Yale endowment.

As is so often the case though, an investor’s willingness and ability can change with the times, especially when bad things start happening. This is exactly the problem now with private equity (and other illiquid assets) and it is starting to burn the holders of those assets. As Jared Dillian points out, “75% of Harvard's endowment is in illiquid crap”:

One of the problems is that several adverse factors are converging on the private equity industry all at once. For one, several private companies are being forced to refinance debt at much higher rates. For another, the business outlook is weaker for small companies than large ones, partly because of financing costs but also because of greater uncertainty. Finally, the market for selling private companies has largely evaporated which reduces or eliminates distributions to investors.

This confluence of factors provides some useful lessons for investors. One is that liquidity is a big deal. The pressures on Harvard right now are unusual and some probably were not predictable. But that’s how things happen. You usually need liquidity at the worst possible time and often for wholly unforeseen reasons.

Another lesson is that even “sophisticated” investors like Harvard’s endowment screw up. There are always pressures to do more at the expense of taking on more risk. It is easy to misjudge. It always hurts when you’re wrong but it hurts more when you’re wrong with your own money.

Finally, the private equity industry is a massive marketing machine as much as a financial services business. It just so happens that various legislation and executive orders are in the works to facilitate greater participation by individual investors. This comes at an especially opportune time when private equity investors like Harvard are choking on the stuff and private equity companies themselves are having a tough time exiting their investments. The whole program looks like an effort to leave individual investors as bagholders.

A good indication of this possibility is the IPO of Blackstone, ticker BX, which was the last time the company sought widespread investment from the public. Here’s how investors did after that episode:

Implications

As stocks continue to edge higher, bonds are bumping up against lows of the year. This is creating a veneer of stability, but tensions just underneath the surface continue to increase.

For one, bond yields in the US have dutifully stopped rising at the level Bessent intervened just a few months ago. Any of a number mishaps or oversights could cause that line to break.

In addition, China’s economy and currency seem to be holding their own, deflationary pressures persist. At the same time, Japan is trying to manage a delicate balance between rising yields and weakening currency while also contending with faltering political support. Also, while the Eurozone is dealing with increasing defense needs, France is running out of road in pushing its extravagant debt even higher.

Bottom line, investors in stocks are amazingly sanguine despite clear signs of risk to global stability. That doesn’t ensure a selloff, but it sure increases the chances of one.

Further, since all of these issues are interrelated, what happens in any one part of the world is likely to quickly ripple through to other parts.

It seems like investors are hearing what they want to hear and disregarding the rest.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

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