May nineteenth, twenty twenty-five to May twentieth, twenty twenty-five

I. Foundation

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

Hysteresis and the Broad-Based Domestic Demand Growth Model: Cycles and Trends

One of the key insights of Endogenous Growth Models is that business cycles cannot be separated from long-term trend growth: the cycle itself affects productivity and, in turn, the direction of the economy’s potential growth path...

Another concept related to endogenous growth is “hysteresis”, which means that if the economy experiences a period of weak demand or subdued overall activity, workers’ incentive to build skills will diminish, and businesses will also reduce investment, especially investment in innovation. All these factors will harm future productive capacity and long-term growth potential.In other words, a period of weak demand may cast a long shadow into the future, causing a permanent decline in potential output...

The reason for discussing this is that many Planet friends are very interested in Powell’s recent moves,

But what matters more to us is that Many signals suggest that in its upcoming policy review, the Federal Reserve may abandon the concept of “compensatory easing” in FATE (Flexible Average Inflation Targeting),the concept of “compensatory easing,” which is one of the important mechanisms for addressing hysteresis.

Draghi delivered a keynote report last 12 on the theme “Responding to the Future Direction of the European Union.” In it, besides noting that “low productivity growth is one of the major problems facing the EU,” he also emphasized a core point:Weak domestic demand is an important cause of low productivity growth.

His reasoning is as follows: since the global financial crisis in 2008, Europe has consistently pursued fiscal austerity. This led to weak domestic demand over the long term. In an environment of insufficient domestic demand, businesses lack the incentive to invest in future productive capacity.This is the path of “weak domestic demand → lower investment → declining productivity,” and it is also how “hysteresis” manifests in reality.

And this point is also clearly illustrated by the recovery after the COVID pandemic: compared with the United States, Europe’s fiscal stimulus was markedly smaller. In addition, Europe experienced a severe energy-supply shock caused by the war in Ukraine (natural-gas prices surged), which held back both investment and trend productivity growth. So, for Europe,the relationship between “hysteresis,” “insufficient domestic demand,” and “low growth” is especially close and pronounced.

Mainstream macroeconomics often treats the study of “business cycles/aggregate demand management” as separate from that of “long-term productivity growth.” Standard macroeconomics usually divides the economy into “short run” and “long run.” Theoretically, in the long run, nominal variables do not affect real economic variables.

So the market often says that business-cycle fluctuations are on one side and the potential long-term growth trend is on the other, and that the two are separate. But what endogenous growth models really emphasize is that they cannot be divided so neatly: business cycles do affect trend growth. We cannot simply say that “growth has a cyclical component and a trend component”; the two are intertwined.

Between the short run and the long run, there is a more important medium term, where the two are intertwined. The medium term is, in fact, a sufficiently long period for businesses to adjust their capacity, technology, or organizational methods—roughly 5 to 10 years. This period is precisely a blind spot overlooked by traditional macroeconomics. During this stage, the interactions among the business cycle, macroeconomic policy, and productivity growth are critical.

From an empirical perspective, truly studying the “long run” is very difficult because real-world data series are not that long. Therefore, in terms of research focus, it is more important to describe what will happen over the next 5 to 10 years.

Therefore, if a recession or a short-term monetary action can affect productivity over a period of 5 to 10 years, that is enough to make it worth close attention as a turning point in the core trend.

It becomes especially interesting if we combine these two parts, because they form a feedback loop:

1) On one hand, as Draghi pointed out, weak aggregate demand → reduced investment → slower productivity growth

2) On the other hand, low productivity growth → pessimistic expectations for future income → weaker current aggregate demand

In other words, weak demand leads to low growth, and low growth in turn suppresses demand, creating a self-reinforcing mechanism. If this feedback is strong enough, the economy may fall into a “stagnation trap,” that is, a persistent state in which low growth and weak demand reinforce each other.

More importantly, even if the “fundamentals are not bad,” “animal-spirits-style pessimistic expectations”—for example, households and businesses losing confidence in future growth—could self-fulfill and trigger this stagnation trap. Supply-side shocks can also trigger a demand-side response.

Weak demand + a weak fiscal response = a combination highly prone to falling into a stagnation trap.

This is another reason why deficit expansion will not stop. The United States understands this, and Europe has understood it too.

2025.05.19

II. Insights

Our Viewpoints and ideas on market...

Bimodal trading in the bond market

In today’s macroeconomic environment, putting on bond trades is quite challenging because the market is constantly being pulled back and forth by two forces, switching repeatedly between the narratives of “economic weakness” and “fiscal risk”:Student-loan policy and the low-oil-price narrative are factors that strengthen deflation expectations and benefit the bond market; a major fiscal spending push, on the other hand, is bearish for bonds..

Chart: The idea of pushing oil prices down has never gone away

The economy may be somewhat soft—not necessarily collapsing, but unlikely to show any bright spots—while fiscal policy is clearly adding pressure...

Under this framework, on different trading days, the market switches smoothly between the two modes, for example, on NFP, everyone focused only on employment; but if there is a Senate vote on a fiscal bill, fiscal policy becomes the main theme, making The bond market now basically runs on two sets of logic in parallel, switching between them very frequently, which makes trading quite difficult.

Our usual approach in this situation is to:

Stay out of it, because there are always clearer trading opportunities.

As noted in “Notes250520: Dollar weakness remains the core trend: hedging, real-money flows, and time-zone trading arbitrage”:

“...compared with the repeated swings in bond selling, the pain of selling stocks, shorting the dollar is the clearest trade direction right now...”

Until one side clearly gains the upper hand, it is better to treat this as a signal to monitor rather than something to trade directly.

2025.05.20

III. Market Pulse

Our latest Comments on the economic and market environment

Dollar weakness remains the core trend: hedging, real-money flows, and time-zone trading arbitrage

Compared with the repeated swings in bond selling, the pain of selling stocks (institutions are underallocated, while retail investors keep adding),

Shorting the dollar is the clearest trade direction right now:

In Notes250515: Continuing to discuss unhedged dollar exposure and the euro-dollar target price where we discussed:

1/ Once there is systematic reductions in allocations to U.S. assets, it could trigger a convexity effect in the foreign-exchange market—that is, capital flows themselves would amplify selling pressure on the dollar, causing exchange-rate movements (the extent of dollar depreciation) to far exceed and diverge from what traditional fundamentals (such as monetary policy or interest-rate differentials) can explain. And the potential volatility would naturally create trading opportunities.

2/ Among those holding the most U.S. assets G10 investors, the largest share is capital from Europe—which means that if the dollar undergoes another genuine adjustment in the future (an adjustment driven by hedging of actual dollar exposure), then EUR/USD will be the key currency pair to trade.

Chart: If we put SPX and EURUSD together

The most striking feature of the EURUSD chart at present is its gradual, steady decline when U.S. stocks rebound, but its rapid, impulsive rally when U.S. stocks weaken—a classic case of “rising fast, falling slowly.”

On the other hand, the market continues to follow a classic time-zone trading pattern: the dollar is weak outside New York hours and actively bought during the New York session. At present, overseas investors are continuously reducing their U.S. asset holdings and increasing their dollar hedges, while U.S. companies continue buying dollars—This mismatch between hedging and real-money flows means that this trading rhythm will continue.

Unless U.S.-based Real Money begins selling dollars on a large scale, or central banks’ dollar selling becomes so extensive that they have to extend their operations into the New York session, this “strength outside the U.S., dollar strength in New York” rhythm will remain the dominant pattern.

Arbitrage strategies can be used to some extent (go long during the New York session and short outside the New York session).