Market Lab Report - Inflation vs global liquidity

by Dr. Chris Kacher

Financials have been strong, and two measures of inflation (CPI, PPI) at the core level came in above estimates, yet major averages S&P 500 and NASDAQ Composite rallied on volume, a sign of strength. Part of the optimism may be due to Trump's pro-business/lower tax stance. CME FedWatch currently predicts one rate cut this year. But GDP growth and the jobs data remain decent in part due to material productivity created by AI. Further, stealth QE remains in place thus the Fed does not have to formally launch QE since its stealth version continues to service record levels of debt and other unfunded liabilities thus global liquidity remains intact. The question is the pace of this liquidity going forward which will be determined by QE in all its forms which include interest rates.

The troubling situation is that rates are where they are at while inflation is where it is at. The Fed has little room to lower rates given the level, persistency, and potential trajectory of inflation. Going forward, spending will drop given DOGE and income and corporate taxes will be cut which will increase capital flows, so to raise revenue, tariffs are needed. Tariffs had been used a number of times to good effect over the last century. It only is in the last couple of decades that they have been utilized much less than in prior times. Therefore, some of Trump's tariffs which he has been using as a negotiating tool may stick. If history is any guide, this may cause a disruption in trade at first but the longer term effect is positive where other countries give the US more business to reduce the impact of the tariffs.

We need to refinance many trillions of dollars in 2025, so with rates where they are, they need to come down.

Ray Dalio in the latest chapters from his latest book outlined a path for the US government to dig its way out of the debt crisis. A large (3% of GDP) deficit cut is required. This could be achieved by making the adjustments come roughly equally from spending cuts, taxes, and interest rate cuts. That would take about a 4% cut in spending, a 4% net increase in taxes overall, and a 1% cut in real interest rates. Elon Musk's $1 trillion in cuts would achieve a 3% cut in spending. This is down from Musk's original and lofty $2 trillion. Dalio points out a 3% reduction or more can be achieved. Further, a 1% cut in interest rates would certainly be bullish for markets and for liquidity. Dalio says even though the Fed says they are not political, deals have been and can be reached.