March seventeenth, two thousand twenty-five to March twenty-first, two thousand twenty-five

I. Foundation

resistance to change and hence greater dependability for the results shown in the past.

The dollar and U.S. stocks have historically fallen in tandem

A key cross-market theme this year is that the correlation between the dollar and U.S. stocks is evolving. In fact, since mid-2, the main factors driving the selloff in U.S. equities (both in absolute terms and relative to European markets) have also been weighing on the dollar;

Specifically:

1/ Rising U.S. fiscal uncertainty

2/ Tariffs increase the risk of stagflation in the United States

3/ Deterioration in U.S. business and consumer confidence

4/ A more optimistic fiscal outlook and attractive asset valuations in overseas markets

Over the past 25 years, it has been extremely rare for the dollar and U.S. stocks to fall sharply at the same time.In fact, the only significant instance of dollar depreciation during a U.S. stock sell-off was the bursting of the U.S. tech bubble in 2000-2002.Although the bear market then was far more severe than the current market downturn, the dollar’s current decline (on a net basis)has already come close to the level seen then and has done so in a shorter period of time.

Chart: DXY vs. S&P500 performance during equity drawdowns of -10+% (since 000)

Importantly, the market adjustment in 00 also coincided with capital flows affecting the dollar and stocks and a similar pattern may emerge in 25, with initial shifts in global asset allocation already underway:

1/ Accelerating inflows into eurozone and Chinese equities

2/ Slowing inflows into U.S. stocks, with a marked cooling in repatriation flows compared with 24 Q4

If we look further at cross-market performance during the current Federal Reserve cycle and use a lower threshold for U.S. stock pullbacks (>-4%), similar dynamics are still evident. This price action stands out, The last time the dollar and the S&P 500 Index fell in tandem was in 24, in the month of 7-8, when labor market concerns and sticky inflation prompted the market to rapidly reprice its expectations for Fed policy, driving bets on more rate cuts.

The common thread behind the trades is rising stagflation risk.

The latest FX & Rates Sentiment Survey from BofA shows a significant shift in investors’ perception that the U.S. policy mix could lead to “low growth + high inflation”:

1/ 75% of respondents believe the current U.S. policy environment could trigger stagflation risk, compared with only 36% two months ago

2/ 65% of respondents expect the most likely cross-asset combination in 25 to be declines in both U.S. stocks and the dollar, compared with only 36% last month

Additionally, at the FOMC meeting in 3, the Fed’s quarterly economic projections also reflected policymakers’ growing concerns about upside inflation risks and slowing growth. However, the Fed’s median rate projection for 27 years ahead remained unchanged.

2025.03.20

II. Insights

Our Viewpoints and ideas on market.

The Federal Reserve’s dilemma

Ahead of the FOMC meeting, the gap between market pricing and macroeconomic reality is widening.Core PCE is above the Fed’s comfort zone, while signs of a slowdown in economic data are accumulating. In particular, the recent correction in risk assets, combined with policy uncertainty, could further weigh on consumer spending and business investment. These data are lagging, and waiting for lagging data would only leave the Fed increasingly behind the economic cycle.

The policy rate is most likely to remain unchanged this time, but the focus is on whether FOMC is willing to offer a possible dovish option. The current expectation is a firm decision with a soft tone (further expressing confidence in the economy and emphasizing that the policy rate will remain at a restrictive level),If signals of slowing market growth continue to strengthen, dovish expectations will build.

Over the weekend, Treasury Secretary Bessent confirmed that the new tariffs will take effect on 4 2, while suggested that trading partners may lower tariffs during 4-6, a possibility the market has not fully priced in. Meanwhile, he described the U.S. stock market's pullback as “healthy”, and continued to emphasize that the economy needs transition to less expansionary government policy——transition to a model that relies less on expansionary fiscal policy.

If we focus on growth, the latest surveys show that businesses and consumers are pull back on spending Signs of slowing economic growth have emerged since the start of the year. The labor market's underlying weakness is particularly worth watching, and the impact of federal layoffs could exceed expectations. If economic data continues to weaken, the core of the FOMC debate will shift from “higher-for-longer” to “when to ease.”

In the baseline scenario, the median dot in this round's dot plot may be lowered, implying three 25bps rate cuts this year rather than the two previously expected by the market. The risk is that if the dot plot is unchanged, the market may react hawkishly. Even so, Powell will most likely emphasize that attention is shifting more toward growth risks than inflation risks.In other words, even if it is not overtly dovish on the surface, the Fed's bias is already shifting.

From a trading perspective, rate volatility may rise in the near term. The market is indeed pricing in expectations of three rate cuts, and If FOMC does not clearly send a more dovish signal, the front end may see a short-term repricing. But given the growing risks to growth, any hawkish reaction could be an opportunity The U.S. equity market is currently in a policy window marked by uncertainty; the key is whether Powell's guidance can manage market sentiment.

2025.03.17

Trump's immigration policy and data issues

The tightening of U.S. immigration policy in 25 Q1 directly cut the annualized inflow of humanitarian and other immigrants from 140 ten thousand to 20 ten thousand, while total annualized net immigration fell from 170 ten thousand in 2024/12 to 70 ten thousand in 2025/2.

For immigrant workers already in the United States, the effects of tighter immigration policy are more complex.

The household survey in the employment report shows that The labor-force participation rate of recent immigrants has remained broadly unchanged, the unemployment rate has edged down, and the job-finding rate for immigrants overall ticked up slightly in 2.However, during the first two months of 2025, the number of immigrant respondents in the household survey fell significantly, suggesting that Tighter immigration policy may make some immigrants unwilling to respond to government surveys out of fear. If these nonrespondents are also afraid to work, their unemployment will not be captured in official data, A delayed supply shock may then emerge on the labor side, and the actual contraction in labor supply may be more severe than official data indicate.

Chart: Declining survey response rate

Based on the current range of forecasts from various institutions, by the end of 2025 the “breakeven rate” for nonfarm payroll growth is expected to fall from 13 ten thousand in 3 to 8 ten thousand.

2025.03.18

FOMC Eve & FED Put

On the eve of FOMC, market sentiment remained cautious. Powell said on 1 29:

“In retrospect, we can see that current policy is restrictive. Compared with before we began cutting rates, policy is now significantly less restrictive, by about 100 basis points. So before considering a policy adjustment, we will focus on tangible progress on inflation or signs of some weakness in the labor market.”

Fed Stance & Macro Setup

Based on this January statement, the Fed believes policy remains in restrictive territory and is maintaining optionality in the near term. But elevated core PCE means the dot plot may face upside risk; the core of market trading is the recalibration of the policy path versus asset pricing. For earlier discussion, see Notes 250317 The Fed's Dilemma。

Market Reaction: Relief Rally or Pain Trade?

A relief rally requires QT a soft pause and a dot plot in line with expectations. In that scenario, risk assets would be relatively strong, equities and FI would rebound, and volatility would fall. Conversely, If the Fed only signals one rate cut and QT is unchanged, the market will see a bull-flattening move. Combined with a resurgence of risk aversion, risk-off trading would dominate (this is the biggest risk).

Directional positioning is currently limited, and the market does not really believe this meeting will be a major catalyst.

QT Matters More than Dots

Current market pricing shows a 60% probability of a pause QT, Two possible scenarios:

1. Soft Pause: reduce runoff to $10B–$20B per month.

2. Stronger Pause: reinvest MBS maturing funds into UST.

Compared with the number of rate cuts, the QT adjustment has a greater impact on liquidity, The Fed's core objective is to control market volatility amid current economic uncertainty, so QT adjustments may take priority over rate-cut expectations, If QT pauses more firmly and cuts rates twice, cyclical stocks will begin to rebound relative to defensives, and the cyclical-versus-defensive pair trade will reach a short-term turning point.

In fact, investors' current default response to a hawkish decision is still to buy the dip, On the one hand, the market is now more focused on growth than on short-term inflation pressures; on the other, even if hawkish signals push rates higher, that effect will be brief while risk assets remain fragile.

To reiterate the baseline scenario: a modest relief rebound and lower volatility

Flows remain cautious, with selling in front-end U.S. Treasuries and buying at the long end. Equity cash volume is 20% below its recent average, and client risk appetite is cooling. The market remains in wait-and-see mode; after growth expectations have been dented, asset prices lack directional trading in the near term.

2025.03.19

BOJ meeting: base case is a rate hike in 7 month

The Bank of Japan held its monetary policy meeting in month 3, on day 18-19, and, in line with market expectations, decided to keep the policy rate at 0.5%.

Kazuo Ueda said:Wages and prices are generally evolving within the expected range... The results of Shunto (the spring labor-management negotiations) announced last week were within expectations, though slightly stronger than expected... The core inflation monitored by the Bank of Japan is rising moderately; it has now exceeded 1% but remains below 2%.

Regarding the rise in food prices, such as rice, he emphasized that Prices will not be forcibly suppressed through rate hikes that broadly affect the economy and prices.He also added that The current gradual pace of rate hikes will not cause the central bank to “fall behind the curve”with a significant increase in the risk.

On U.S. tariff policy and its effects, he believes uncertainty is rising rapidly. At the same time, the virtuous cycle in Japan's domestic economy is strengthening. He views the recent rise in long-term interest rates as part of the market's normal rate-setting process, and He said that the situation has not yet reached the point where the BOJ would need to expand its government bond purchases further.

The BOJ still has no urgent reason to accelerate rate hikes and will continue with a gradual pace of increases; against this backdrop, A rate hike in 7 remains the baseline scenario. However, if the yen depreciates sharply and rapidly, a hike could come earlier; conversely, if the House of Councillors election ahead of the 7 policy meeting leads to political instability, the timing of a hike could be delayed.

2025.03.19

Continuing the discussion of the combination of a falling dollar and falling U.S. stocks

A weaker dollar and falling U.S. stocks are not an unusual combination, but this dynamic is usually difficult to sustain over the long term. And The persistence of the current episode is approaching that of several of the most notable and prolonged episodes of the past 25 years.If concerns about the U.S. growth outlook continue to build and the return outlook for overseas assets becomes more attractive, The synchronized effect of this round of dollar weakness and equity-market correction could last longer than in similar historical episodes, especially while U.S. assets remain significantly overweight.

This combination is not unusual over short periods (on a daily basis), but episodes that last longer are relatively rare. The current market trajectory is approaching several of the most significant past episodes. However, this round may be different, mainly because market positioning remains tilted toward U.S. assets, If the market continues to view U.S. policy uncertainty as a problem unique to the United States, capital may flow further out of U.S. stocks and into assets in other regions.

Capital rotation into euro-area assets has been observed, but overall positioning remains stable, especially Overseas investors' holdings of U.S. assets have not yet undergone a major adjustment This is also why the baseline expectation still favors a recovery in the dollar's strength this year. The main reasoning includes broader trade and tariff risks, as well as the possibility that the market has over-adjusted its growth outlook for the United States and the euro area.

As mentioned before, Europe's underlying fundamentals will not accelerate too quickly; this is a long-cycle process. Rotation and rebalancing between Europe and U.S. equities will most likely take place during this period, and we will readjust some of our current positions.

Further reading: Notes 250307 Nonfarm payrolls commentary & a rare macro trading combination

2025.03.20

Don't rush to predict the pain threshold

As policy, economic, and market uncertainty rises, speculation is growing over whether the White House or the Fed will intervene. The general view is that Both have some kind of Threshold for Market Pain, or market pain threshold, but at present it is unwise to bet too far ahead on a policy shift.

1. White House intervention is unlikely, and its effect on the dollar is uncertain

Tariffs: the market has shifted from viewing high inflation and risk premia as dollar-positive to seeing pressure on economic growth and deteriorating trade relations as dollar-negative

Deregulation: if it boosts energy production and lowers oil prices, it could affect the dollar through lower interest rates and the oil-dollar correlation

Fiscal expansion: if fiscal stimulus continues, the dollar may benefit in the short term, but this is unsustainable in the long term

2. Fed intervention is even less likely, and the dollar still faces downside risk

If the Fed worries that falling U.S. stocks are worsening the negative wealth effect, it may send a more dovish signal. But inflation remains above target, and the bar for a policy adjustment is high; the dovishness would be verbal only, so do not place too much weight on words.Powell also directly denied the possibility of a “policy put” at the 3 FOMC meeting; in the near term, the market should not expect too much from a Fed bailout.

2025.03.21

Risks around European fiscal spending are skewed toward overreaction

First, it is important to be clear that Germany's fiscal shift has indeed improved growth expectations for European trades, especially with a significant increase in defense and military spending and infrastructure investment, but its impact in driving overall economic inflation and growth is far smaller than it appears or, in other words, as we have continued to emphasize in our notes recently, This takes time.

The euro-area economy has not yet fully recovered from the drag of the pandemic and energy shock. Significant spare capacity remains in several industries, for example in the form of reduced average working hours or underused capital. Among these, This is particularly evident in manufacturing. Germany, a central country in the fiscal expansion, also faces low utilization of its production factors.Against this backdrop, When businesses face additional demand, they can often raise capacity utilization without adding new inputs, so marginal costs do not rise significantly.

Chart: Significant spare capacity remains in euro-area manufacturing

With a negative output gap, the Phillips curve tends to flatten, meaning inflation responds much less to demand. This nonlinear relationship means that Even if demand strengthens, inflation may recover more slowly than its historical average.

In addition, structurally, spending is concentrated in military and infrastructure investment, which has an inherently limited transmission channel to CPI. These areas have very low weights in the household consumption basket; such spending is more directly reflected in the GDP deflator.

To elaborate, This round of fiscal expansion does not involve giving money to households or cutting taxes. Instead, it consists of government-led “non-consumption spending,” such as military expenditure and infrastructure construction. It is essentially capital expenditure that supports the economy but has a limited effect on everyday consumption.Even if costs rise and prices increase in these sectors, it is difficult for this to be passed through effectively to ordinary consumers, so the effect on CPI is limited.

The GDP deflator measures price changes for goods and services across the entire economy, including government purchases and investment goods. It is a broader, more macro-level price indicator than CPI. Thus, price pass-through from government-led spending such as defense and infrastructure is more readily reflected in the GDP deflator.

If the market looks only at CPI to assess inflation risks, it will misjudge the impact of this round of fiscal expansion on nominal economic variables.It may not raise headline inflation, but it will affect the deflator and nominal GDP, thereby influencing debt/GDP, tax revenue growth, profit-and-loss structures, and more, with implications for both rates and credit. In other words, “not CPI inflation, but reflation.” This is a key trading judgment.

Continuing from the labor-market perspective, job creation is constrained by capacity limits, most of the additional demand for labor may be met by extending average working hours rather than creating a large number of new jobs, on top of that, Rising manufacturing wages do not appear to pass through significantly to the services sector, making it difficult for this to turn into a broad-based inflation spiral; it may also ease gradually as labor shifts from sectors with weak growth to those benefiting from fiscal expansion.

Chart: Manufacturing wage increases do not pass through significantly to services, whereas services wage increases do pass through to services

Foreign-exchange markets also provide some additional disinflationary cushion in the short term. EUR has rebounded 4% vs USD since Germany's election, and TWI has risen 2.65%,Over the next 12-18 months, this will continue to weigh on import prices and exert downward pressure on CPI. Even if EUR later retraces somewhat, the effect will be delayed, keeping short-term inflation risks in check.

Over the medium term, this round of European fiscal stimulus is in fact aimed at the supply side. It will expand supply-side potential over the medium term and curb price increases resulting from stronger demand.

Overall, If the market reasons simplistically that “fiscal expansion = higher inflation = ECB hawkish,” the risk is skewed toward overreaction.The more likely path is one led by upward growth revisions, with inflation recovering moderately but nowhere near posing a reflation risk. With ECB remaining data-dependent, asset pricing should focus more on growth-sensitive assets and a return to relative-valuation norms.

Read alongside: GS - Limited Inflation Upside from Europe’s Fiscal Shift (source of the chart in today’s article)

2025.03.21

III. Market Pulse

Our latest Comments on the economic and market environment

Action plan to boost consumption

The Consumption Promotion Action Plan issued by CN sets out the following key measures: (1) raise household incomes, moderately increase minimum wage standards, expand income sources from financial markets and rural housing, and accelerate repayment of corporate arrears; (2) increase social spending, establish childcare subsidies, raise residents’ basic pension and basic medical insurance subsidy levels, and encourage workers in flexible employment to participate in social insurance; (3) expand the supply of consumer services, focusing on industries such as elderly care, childcare, housekeeping, culture, sports, and tourism, and promote the application of AI technology in consumption; (4) steadily advance the opening up of the services sector, including telecommunications, healthcare, and education, while increasing imports of services such as healthcare, culture, and entertainment; (5) double subsidies for consumer-goods trade-in programs to RMB 3000 hundred million yuan and encourage local governments to provide more support; (6) allow local governments to use special-purpose local government bonds to acquire existing housing and lower housing provident fund loan rates; (7) implement paid leave and remove consumption restrictions such as those on car purchases; (8) increase central government investment in services and skills training, provide interest subsidies, and expand the issuance of personal consumer loans.

The Action Plan broadly follows the policy direction set at the national meeting and further fleshes out the measures. Specific details remain to be announced, such as the size and scope of the much-anticipated childcare subsidies and how local governments will use special local government bonds to reduce housing inventories.

However, Local governments’ fiscal capacity remains a challenge, so the boost to consumption is certain to remain relatively modest in the near term, the scale of the trade-in subsidies is in line with market expectations, with little that is surprising. This is still a long-term allocation position; this part will not move quickly in the short term. At least, after everyone has gone through a round of tech, coming back to this will certainly feel unfamiliar.

2025.03.17

Indian market posts its biggest one-day gain in nearly two months

The Indian market posted its biggest one-day gain in nearly two months, with the Nifty index rising almost 1.5% to close at a one-month high, breaking above 22,800 points.Lifted by global market sentiment, the index opened higher and extended its gains, continuing yesterday’s rebound. Easing concerns about a U.S. recession, China’s stimulus measures and strong domestic fundamentals in India have together supported the recent recovery in market sentiment.

Further reading: Notes 250313 What Indian trades can look like

Be sure to read this further reading if you haven’t already!

The index maintained its gains throughout the session, Bank stocks were the main support, helped by the overnight rise in ADR, the market advanced broadly, with every sector closing higher. Real estate, autos and metals led the gains, while IT, fast-moving consumer goods and energy rose relatively less.

Mid- and small-cap stocks performed more strongly, the Midcap index rose 2.2% and the Smallcap index rose 2.7%, reflecting clearly bullish sentiment; the advance-decline ratio reached 3:1.The India market volatility index (India VIX) fell 1.5%, signaling a rise in risk appetite.