May nineteenth to May twentieth, two thousand twenty-five

I. Foundation 

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

Hysteresis and the broad domestic demand growth model: cycles and trends

One of the key insights of Endogenous Growth Models is that the business cycle cannot be separated from long-term trend growth: the cycle itself affects productivity and, in turn, the trajectory of potential economic growth...

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 will have less incentive to build skills, and companies will reduce investment, especially investment in innovation. All these factors will damage 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 friends in the community are very interested in Powell’s recent moves,

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

Last year, in 12, Draghi delivered a keynote speech titled “Responding to the Future Direction of the European Union.” In the speech, besides noting that “low productivity growth is one of the major problems facing the EU,” he also emphasized a central point:Weak domestic demand is an important cause of low productivity growth.

His reasoning is as follows: since the global financial crisis of 2008, Europe has pursued a persistently restrictive fiscal policy. This has led to prolonged weakness in domestic demand. In an environment of insufficient domestic demand, companies lack the incentive to invest in future productive capacity.This is the “weak domestic demand → lower investment → declining productivity” pathway, and it is precisely how hysteresis manifests in practice.

And this can also be seen very clearly in the recovery after the COVID pandemic: compared with the United States, Europe's fiscal stimulus was clearly much smaller. In addition, Europe also experienced a severe energy supply shock caused by the war in Ukraine (a surge in natural gas prices), which dampened both investment and trend productivity growth. So, for Europe,The relationship between “hysteresis,” “insufficient domestic demand,” and “low growth” is particularly close and clear.

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” components. 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 they are separate. But what endogenous growth models really emphasize is that they cannot be divided so clearly. The business cycle does affect trend growth; it is not enough to say that “growth has a cyclical component and a trend component”—they are in fact intertwined.

Between the short run and the long run is the more important medium run, where the two intertwine. The medium run is a sufficiently long period for companies to have the opportunity to adjust their capacity, technology, or organizational structure—roughly 5 to 10 years. This period is precisely a neglected blank area in traditional macroeconomics; at this stage, the interactions among the business cycle, macroeconomic policy, and productivity growth are crucial.

From an empirical perspective, truly studying the “long run” is very difficult because real-world data series are not that long. Therefore, for research purposes, 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 for it to be treated as a turning point in the core trend that deserves close attention.

It becomes particularly interesting when these two parts are combined, because they form a feedback loop:

1) On the one hand, as Draghi pointed out, weak aggregate demand → less 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 restrains demand, creating a self-reinforcing mechanism. If this feedback is strong enough, the economy may fall into a “stagnation trap”—a persistent state in which low growth and weak demand reinforce each other.

More importantly, even if the “fundamentals are not bad,” the emergence of “animal spirits-style pessimistic expectations”—for example, households and companies losing confidence in future growth—could trigger this stagnation trap in a self-fulfilling way. Supply-side shocks can also spill over to the demand side.

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 come to understand it too.

2025.05.19

II. Insights 

Our Viewpoints and ideas on market.

III. Market Pulse 

Our latest Comments on the economic and market environment

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

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

Shorting the dollar is currently the clearest trade:

In Notes250515: continuing the discussion of unhedged dollar exposures and the EUR/USD target price In that piece, we discussed:

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

2/ Among the investors with the largest holdings of U.S. assets G10, the most significant investors are capital from Europe—which means that if the dollar undergoes another genuine correction later on (a correction driven by hedging of actual dollar exposures),EUR/USD will be the key currency pair to trade.

Chart: Bringing SPX and EURUSD together

The most striking feature on the EURUSD chart right now is its slow, steady decline when U.S. stocks rebound, versus a rapid, impulsive rise when U.S. stocks weaken—a classic “rises fast, falls slowly” pattern.

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. As overseas investors continue to reduce their U.S. asset holdings and increase their dollar hedges, U.S. companies continue to buy dollars—This mismatch between hedging and real-money demand means that this trading rhythm will continue.

Unless U.S.-based Real Money starts selling dollars on a large scale, or dollar selling by central banks becomes so heavy that their operations must extend into the New York session, this pattern of “strength outside the U.S., then strength in New York” will remain the dominant theme.

A suitable arbitrage strategy would be to go long during the New York session and short outside the New York session.

2025.05.20

Note: Everything in this article is for reference only and does not constitute investment advice or serve as a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as the basis for their decisions.