The economic uncertainty we talked about in last week’s commentary has led to a turn for the worse in financial markets this week, and for one asset class, in particular. Small cap US stocks last set a record high in late November last year, as unbridled optimism among small businesses in the immediate post-election environment led to a burst of outperformance against their large cap counterparts.

But the optimism quickly dissipated in the waning days of 2024, and never recovered. As of Thursday’s close, the S&P Small Cap 600 index was down -19.2 percent from the November 25 high, just shy of the technical bear market threshold of minus 20 percent (the index is up slightly this morning as US equities once again attempt a bounce). By comparison, the S&P 500 index of large-cap stocks was down a bit over ten percent yesterday from its last record high of February 19. In Wall Street parlance, a ten percent drop constitutes a technical correction (again, equity markets are up as we write this on Friday morning, but whether the bounce is sustainable through the end of the day is anybody’s guess).

Negative Vibes All Around

The Trump administration is getting a cold blast of the negative vibes that weighed heavily on the Democrats during last year’s election. An influential consumer sentiment index published by the University of Michigan came out twenty minutes ago and showed confidence levels plummeting over the course of the last month. The preliminary March number for the Michigan sentiment indicator was 57.9, well below the 74.0 figure registered at the end of last year, below economists’ March consensus forecast of 64.0, and in fact the lowest reading since November 2022. Consumers increasingly expect inflation to increase, with the year-ahead expectation now at 4.9 percent, up from 4.3 percent last month (and well above the actual current Consumer Price Index figure of 2.8 percent).

The relatively poor performance of small cap stocks in this environment is perhaps unsurprising. Small businesses, as a rule, do not have the same arsenal of defenses against the negative effects of increased tariffs that larger companies do. Nor do they have the same clout in obtaining carve-outs from the government as, say, the major auto manufacturers showed last week when they got a reprieve from the 25 percent tariffs threatened against Mexico and Canada. In past market cycles, a pronounced downturn in small cap stocks has been seen as a harbinger of growth concerns. Indeed, a JPMorgan Chase economic report published this week opined a 40 percent chance of a US recession sometime this year, consistent with recent downgrades of the economic outlook by other major financial firms including Citi and Goldman, Sachs.

Large Cap Signals Less Clear

The growth concerns pushing small caps towards a bear market are not yet evident in a meaningful way among large caps. Much of the downward direction in the S&P 500 thus far can be attributed less to general growth concerns and more to the specific performance of the so-called Mag Seven – the AI-themed megacap tech stocks that have been responsible for much of the upside over the past two years and which collectively make up more than 30 percent of the S&P 500’s total market cap. The S&P 500 equal weight index, which evens out the influence of the market cap heavyweights, is only down 3.3 percent year-to-date, so not yet close to correction territory.

As with everything else in this upside-down environment, it all comes back to the need for clarity, for getting rid of the frenetic on-off approach to major economic policy questions, and for de-escalating the trade war. That would likely go a long way towards improving those morose sentiment vibes among consumers and businesses. This week’s inflation numbers showed that, left to their own devices (i.e., without the implied or actual threat of those ill-advised tariffs), consumer prices should continue to trend towards the Fed’s two percent target. That won’t happen, though, if the environment is such that nobody can make rational decisions around spending, saving or investing.

It’s Friday morning. Do you know where your tariffs are? Of course you don’t, because nobody really knows what is going on with all the pinballing decrees on which tariffs apply to which countries, with exceptions and deferrals and audibles called at the line of scrimmage and then reversed for whatever combination of reasons or no reason at all. It has been a strange week. In the midst of all the weirdness markets have been doing what markets normally do when nobody has a clue about anything – selling out of risk assets, especially those with pricier valuations, and buying safety. As this week got underway, the yield on the 10-year Treasury note, at 4.15 percent, was 0.65 percent lower than where it was just six weeks ago – a massive move in percentage change terms for what is supposed to be the world’s safest asset. As the week wore on, though, investors seemed to find safer waters in shorter maturities, with the 2-year note falling below four percent while the 10-year ticked up a tad.

Here Come the Growth Concerns

Markets don’t like uncertainty, and neither do businesspeople who have to make decisions about how many widgets to produce based on data like input costs (raw materials, labor etc.) and demand trends. It’s hard to make these kinds of decisions when you don’t know whether something you need to import is going to be 25 percent more expensive next month on account of some new tariff, or whether wages are going to be pushed up as more immigration cuts take place, or whether your customary buyers will decide they’re tapped out and need to put aside discretionary spending choices in order to buy $10 cartons of eggs. The not knowing is worse than dealing with the actual fact of a tariff policy that is announced, implemented and unchanged. At least you can make plans around a known fact, even if that fact is a negative for your sales.

These kinds of concerns are starting to show up in economists’ growth forecasts for 2025. We have already seen a couple notable downward moves recently in high-profile consumer and business sentiment surveys. Then, on Monday of this week, the Atlanta Fed tossed a stunner into the daily economics chat with its latest GDPNow estimate, projecting that real GDP growth for the first quarter will be negative – yes, negative – 2.8 percent (by the end of the week that number had crept up to minus 2.4 percent, but still). Worries about growth pushed aside last week’s chatter about inflation – even if those draconian tariffs don’t happen and inflation remains in check, the slowdown in business activity could lead to a recession sooner rather than later.

Now, the Atlanta Fed number should be taken in stride. Because it is absorbing a constant stream of data in real time, the GDPNow figure is quite volatile and at times – like now – will be far away from the consensus forecasts of economists. The Blue Chip consensus, one such forecasting data point, currently has Q1 GDP coming in at a midpoint around positive 2.4 percent. We expect that when all is said and done, real growth for the first quarter will still be positive, but somewhere below two percent. Evidence of a growth slowdown is accumulating, including the most recent jobs report from the BLS this morning showing nonfarm payroll gains of 151,000, below economists’ forecasts of 160,000, while the unemployment rate also ticked up slightly from 4.0 to 4.1 percent. There was a chance the numbers could have been much worse than that, though, so we’ll take what we can get.

Still Time to Reverse

So where do things go from here? It’s anybody’s guess what the next policy move – or for that matter the next tweet, which seems to be where it all happens – is going to be. If anybody cared to listen to us, though, we would say that getting rid of uncertainty is job number one. Look, if you announce a tariff, and then the car companies call you up and say that the tariff would be devastating for your industry, and then you hear the same thing from farmers and from food manufacturers and everyone else – well, maybe it just means that these tariffs are a bad idea with very little upside and should be shelved entirely rather than the current silliness of a new delay or carve-out or “review” every day. Markets, businesses and consumers would all be most appreciative. Growth would likely be slower this year than last anyway, regardless of government policies, based simply on the normal course of things in the economic cycle. But hastening the decline, especially with the attendant lingering specter of higher inflation, is the opposite of good policy.

Inflation is back at the top of the list of economic concerns felt by everyone from the voting members of the Federal Open Market Committee, to portfolio managers trying to figure out target maturities for their bond allocations, and to families dreading the next trip to the grocery store. A couple weeks ago, those concerns heated up with the publication of the January Consumer Price Index (CPI) report, a function of the Bureau of Labor Statistics, which showed inflation coming in hotter than expected.

This morning, though, we got a second take on the subject with the Personal Income and Outlays report issued by the Bureau of Economic Analysis. This report contains the Personal Consumption Expenditures (PCE) index, which happens to be the inflation indicator most closely studied by the Fed in its monetary policy deliberations. Happily for all of us worried about inflation’s recent stickiness, the PCE numbers for January were right in line with expectations. Significantly, the year-on-year gain in core PCE, which excludes the volatile categories of food and energy, fell to 2.6 percent from 2.9 percent last month.

Similar But Different

Any macroeconomic data point, whether trying to measure growth in output, changes in the labor market or changes in consumer prices, is imperfect; it applies a formula to measure some subset of all the possible data available. The CPI and the PCE both measure consumer prices, but the methodology is different. The Bureau of Labor Statistics, the organization responsible for the CPI, has a helpful little guide to tell us that there are four basic differences in approach that lead to the variations we observe between the two indexes: (i) the formula used (notably, the PCE reflects consumer substitution among detailed items as relative prices change), (ii) the relative weights applied to different categories of goods and services; (iii) the scope effect (the PCE includes the change in prices, not just of items consumed by households but also by institutions serving households such as employer coverage of health care costs); and (iv) other effects, a sort of grab bag of residual differences such as seasonal adjustment methodologies. One of the outcomes of the “scope effect” difference is that the PCE encompasses a wider range of products and services covered – i.e., its “market basket” is bigger than that of the CPI. This is perhaps one of the key reasons why the Fed is more inclined to use the PCE as its go-to inflation metric when deliberating changes to monetary policy.

Still Stuck Above Two

Investors were relieved to see the PCE in line with expectations; a hotter reading probably would have knocked out whatever good feelings remained after a tough week that has pushed both the S&P 500 and the Nasdaq Composite into negative territory for the year to date. As we write this on Friday morning, US stocks are trading flat to slightly down. The main concern, of course, is that with both inflation measures still stuck above the Fed’s two percent target rate, the next few months may not be as benign. In the eternal will-they-won’t-they guessing game about tariffs, the latest word is that the 25 percent hit to products from Canada and Mexico is still on track for March 4, which leaves March 3 (next Monday) as the last day for one of those famous last minute rabbits out of the hat to kick the can down the road.

More concerning than the pinballing policy decrees, though, is growing evidence that inflationary expectations among households and businesses are taking root more firmly than they did three years ago when the indexes were at their high points. Back then, sentiment surveys showed that most people expected inflation to be transitory and back to normal within two to three years. Those expectations are changing now, given both the stickiness in prices over the past half year and the specter of tariffs hanging over the near future. We can only hope that some policymakers are paying attention. There is no sugarcoating the potential detrimental effect of excessive tariffs, on consumer prices and on growth.

This Sunday, the good citizens of Germany will go to the polls to vote for the country’s next government. The composition of that government will likely not be known for some time, since no party is on track to win an outright majority. But it will almost certainly not be led by Olaf Scholz, the current chancellor who set this whole snap election thing in motion last November by dismissing one of his own partners from the fragile coalition of the Social Democrats (Scholz’s party), Greens and Free Democrats. More likely will be a yet-to-be-identified coalition led by the Christian Democrats (CDU) and its leader, Friedrich Merz.

Growth Engine No More

This new government will inherit a bevy of economic, political and social problems plaguing a country that was once a byword for “Europe’s growth engine.” That growth has not been in evidence now for some time, with GDP more or less stagnant for more than two years, domestic infrastructure needs not being met (thanks in part to an unduly restrictive constitutional “debt brake” capping Germany’s structural deficit at 0.35 percent of GDP), and a business model largely dependent on high quality exports in a world of worsening conditions for global trade and a key trading partner, China, with its own major problems.

But hey, if nothing else, the new incoming chancellor can at least enjoy (for now) the performance of German equities, which have been on a bender so far this year.

A Zeitwende for Bargain Hunters?

The German word “Zeitwende” signifies a major change of some kind that alters the present course of events. Chancellor Scholz used the phrase back in 2022 to describe a major overhaul of Germany’s foreign policy and defense strategy in response to Russia’s invasion of Ukraine that year. The country is due for another Zeitwende this year – specifically, a bold political decision to scrap that outmoded debt brake that has kept policymakers from carrying out much-needed investment in infrastructure and social spending. There has been talk of this happening among political analysts observing the electoral vibe ahead of this weekend’s elections, and some of that talk may be fueling investors’ optimism that a new set of policies could boost economic fortunes – and lift those outperforming shares on the DAX index even further.

Where that talk is not being heard with much conviction, though, is among the candidates themselves. Merz, the CDU leader, has been tepid in replying to questions about whether his government would be ready to ditch the brake. At this point, Merz has no clear idea of what his coalition is even going to look like, let alone what kind of policies would come out of what promises to be a protracted set of negotiations and concessions. According to the latest polls, the CDU is on track to win around 30 percent of the vote. In second place, alarmingly, is the far-right Alternative for Germany (AfD) party, currently polling around 20 percent. Scholz’s beleaguered SPD is in third place with around 15 percent, closely followed by the Greens in fourth. For the time being, at least, both the CDU and the SPD have declared themselves unwilling to form a national government that would include the AfD. We will see what the reality looks like after the results come in on Sunday.

Even if the new government does manage to shake off its customary lethargy and enact some vigorous new policies, it will still be operating in the growing shadow of a wholly different set of conditions for global trade and, for that matter, global security. Western Europe has been a key member of the world order that lasted for eighty years since the end of the Second World War. That order is unraveling, and the continent’s future in whatever takes its place is uncertain. The times are going to call for bold thinking and decisive action by the new government in Berlin, traditionally the center of European policymaking. And that will have to come sooner rather than later, if both the trust and support of the German people and the current optimism of German equity investors are to be in any way validated.

Every election cycle has its own peculiar trope at the center of the narrative, the very tangible thing that brings swirling abstract narratives into recognizably defined three-dimensional space. For the 2024 campaign, that thing was the price of eggs. The complexities of global supply chains, the arcane accounting practices for billions of dollars of government expenditure, the extreme distortions of consumer demand trends during and after the Covid pandemic – all the many variables involved in the highest levels of inflation experienced since the 1970s boiled down to one simple formulation: Have you seen the price of eggs lately? Yes they had, and they were not happy about it, and they made their point on November 5.

The Chickens and the Eggs

Given the prominent place afforded last year to that one food category as a proxy for the entire inflation story, it is perhaps an unfortunate coincidence that eggs are back in the news recently for reasons unrelated to the inflationary forces at play for much of the past three years. The spread of avian flu has caused havoc among the chicken farms from which our Grade-A cartons begin their long journey to our kitchen tables. The price of eggs today is roughly double what it was a year ago, and soared by 15 percent in the month of January alone. The flu has necessitated the slaughter of millions of chickens, drastically reducing supply, and the magnitude of the resulting price increases for eggs accounted for fully two-thirds of the total increase in food prices last month, according to the latest Consumer Price Index report issued by the Bureau of Labor Statistics this past week.

But it’s not just about eggs. The Fed doesn’t pay as much attention to the volatile categories of food and energy products as it does to so-called core inflation, the more stable baskets of goods and services like apparel, medical care and shelter. The problem is, these categories are proving to be stubborn as well.

Gimme Shelter

Non-food and energy services, in particular, have not come down at the rate the Fed was expecting to see a year ago. For the last twelve months, prices for shelter (rent and owner’s equivalent) have increased 4.4 percent while transportation services, of which airline travel is a major component, have gone up 8.0 percent. That has kept the core CPI number (the gray dotted line in the above chart) stuck at or around 3.3 percent since the middle of last summer. The Fed went ahead with its first rate cut in September regardless, thinking that the numbers would continue to decline, but here we are in February and 3.3 percent is still the number for core inflation.

And That’s Without New Tariffs

The seeming intractability of inflation alone would strongly suggest a continued pause by the Fed, with no rate cuts likely for the foreseeable future. But that, of course, doesn’t take into account whatever tariffs are eventually going to make their way into law. As we noted in our commentary last week, the only consistent aspect of the new administration’s tariff policy so far is its inconsistency, with policymakers saying one thing one day, watching how markets react, and saying something else the next day (or the next hour). The word in vogue this week has been “reciprocal tariffs,” which sounds like a sort of tit-for-tat policy aimed at matching the tariffs other countries set on products we currently import. Or is it? Does it include things like the 20 percent VAT applied to many European exports? How about structural barriers on products from places like Japan and India? And when? The latest indications point to April (maybe) as the likely start date (unless something else comes up in the meantime, and notwithstanding carve-outs and exemptions and all the rest of the baroque ornaments of this administration’s approach to tariffs).

All this remains to be seen, and markets have yet to exhibit any overriding concerns. Meanwhile, interest rates are likely to remain where they are, and vegan baking recipes that call for egg substitutes are likely to grow in popularity.

Three months ago, to the day, we wrote our first post-election commentary entitled “The Markets Are The Guardrails,” the idea being that whatever craziness might be going on elsewhere in the new administration, on the economic front at least their wildest ideas would likely be tempered by the reaction of stock and bond markets, about which these people, to a person, care deeply. So far, we would say that our prognostication back in November has been validated. There is plenty of crazy stuff going on elsewhere, and because our weekly commentary is about economics, not politics, we will leave it to others to delve into that side of things. Where the economy is concerned, though, the guardrails seem to be holding. By the numbers, neither equity nor fixed income investors should have much to complain about for the year so far – the S&P 500 is up and the 10-year Treasury yield is down for this time. Over the past three months, though, the main discernable direction is sideways, a whole lot of nowhere.

Tariff Kabuki

This past week has been an excellent illustration of the guardrails mindset, and the extent to which Wall Street appears to believe the supports will continue to hold. News hit the airwaves last weekend that those 25 percent tariffs against Canada and Mexico that had been floated earlier were, indeed, going to come into effect this week. “On Tuesday” was the promise. Equity futures markets plunged while financial opinion columnists provided a refresher course for investors on how far stocks have to fall before the market’s circuit breakers come into effect to temporarily halt trading (at three escalating levels of 7, 13 and 20 percent down from the open). Markets don’t like tariffs for all the reasons we have discussed many times in these pages, mainly because they are likely to put upward pressure on inflation and downward pressure on growth, otherwise known as stagflation.

On Monday the Wall Street Journal, not exactly a mouthpiece for the anti-capitalist left, featured an article the headline of which read “The Dumbest Trade War In History.” Something else the Trump administration cares about, alongside the performance of financial markets, is critical press coverage (much as they may be loath to admit it). Now, there is no obvious causal link between the WSJ headline and the announcement, about an hour into trading on Monday, of a “pause” in the tariffs with Mexico (and then, shortly afterwards, likewise for Canada, in both cases on fairly flimsy pretenses). No matter – the market quickly formed the consensus opinion that the guardrails had held again and prices never came near those circuit breaker levels. This is not to say that we have heard the last of the tariff threats – far from it. We expect this will continue to play out like a Japanese Kabuki drama for months to come – lots of histrionic shouting and dramatic movements, but in the end more performative than real. We may be wrong about that, and so might the market. But for now, the “guardrails will hold” mindset is the common wisdom.

Waiting For Tax Cuts

If the perceived guardrails against punitive tariffs form a kind of downside support level for stocks, then the upside formula largely concerns tax cuts. Lots of things that governments do have no bearing whatsoever on the market, but the one thing that always draws the spotlight is a new round of tax cuts. These are currently percolating as congressional Republicans try to put together a budget reflecting the administration’s economic priorities, and being Republicans, tax cuts are front and center (though, interestingly, the carried interest loophole so beloved of hedge fund and private equity titans is rumored to be on the chopping block – we’ll believe that when we see it). Extension of the 2017 corporate and individual tax cuts with perhaps some new ones as well may give stocks enough upside to push through the sideways corridor that has persisted for the past three months.

That upside may be short-lived, though, come March 14, which is the latest deadline for government funding approval. Noises are starting to emerge from the hitherto-quiescent Democratic side of the aisle that approval may not be forthcoming given what has been going on elsewhere in the federal government over the past two weeks (i.e., that “crazy stuff” we noted above that markets normally ignore). It’s too early to tell how serious these threats might be, but bear in mind that the very slim margin of Republican control in the House means that Democratic votes will ultimately be necessary to avoid a shutdown. Stay tuned, for there is never a dull moment.

Over the past two years, as advances in artificial intelligence turned into a massive tailwind for the US stock market – carried aloft by a relatively small number of companies with a credible claim to be at the center of the AI story – skeptical observers compared the phenomenon to the Internet boom of the late 1990s. That boom, as anyone around at the time will no doubt recall, ended with a spectacular crash at the turn of the millennium. So long to Pets.com and its ilk, popped into weightless effervescence as the dot-com bubble burst. So too, the AI doubters have insisted, will be the fate of those enterprises today with their promises of world-changing feats of economic productivity brought about by their high-octane large language modules (LLMs).

The vibe of Schadenfreude was no doubt making its rounds among the critics of AI share prices this week, watching as the likes of Nvidia and Microsoft tumbled on Monday when a barely-known Chinese operation called DeepSeek burst onto the scene and, well, deep-sixed just about everything that had hitherto been conventional wisdom about generative AI – especially the billions and billions of expenditure dollars thought to be needed to make bigger and better LLMs, and the many megawatts of energy needed to power the data centers that bring them to life. DeepSeek appears to have capabilities more or less on par with those of ChatGPT, the iconic platform introduced by OpenAI in late 2022. But – to explain why all those AI-related stocks sank on Monday – DeepSeek can do all that at a fraction of the cost. Nor does this appear to be some kind of elaborate Chinese ruse. The company behind DeepSeek, a hedge fund called High-Flyer that specializes in AI applications for trading in financial markets, has made its training results public and its systems available on an open-source license. Anyone who wants to build their own programming on top of these systems can do so without permission. Scant wonder, then, that DeepSeek shot to the top of app store downloads in the US this week.

Getting back to those share prices for Mag Seven names (the Wall Street shorthand for those hitherto high-flying AI stocks). Is DeepSeek the catalyst for the bursting of the bubble – if indeed that is the right term to use? We imagine there will be plenty of short-term volatility in these shares as bargain-hunters do their thing, skeptics do theirs, and asset allocators interpreting all of this as a signal for repositioning between value and growth stocks do theirs. For our part, we think this is a new chapter in what we expect to be a very long story, with an ending that is nowhere near in sight. The capabilities of AI LLMs has grown significantly since the release of that first ChatGPT app. Now we have evidence that further growth is achievable with potentially greater cost and energy efficiencies – which is likely to spark more interest and produce new entrants whose names we don’t yet know. In turn, the overall potential market size is likely to grow. The established players will have a role to play here. At a recent tech conference, Nvidia CEO Jensen Huang pointed to robotics as the next major use case, with AI-empowered robots taking over a large swath of agent functions throughout the massive (and often unproductive) services economy.
“Agentics”—the techy buzzword for this – could be a word you hear circulating around a great many cocktail parties this year.

There will be winners and losers, in other words, as there always are with radical breakthroughs. Think back to Internet 1.0 in the late 1990s. Lots of those names went out of business, while others (such as Amazon) went on to be the behemoths of successive chapters in that story. There will be risks and there will be opportunities. But for better or for worse, artificial intelligence is very likely going to be an increasingly influential component of the global economy. The newest chapter of the story just got under way.

The 1980s was a colorful decade for many reasons, and not just limited to the cultural icons of the day like Boy George or Max Headroom. The economic arena had its own personalities. There was Michael Milken, the swaggering Drexel Burnham Lambert bond trader perched at his X-shaped desk in Beverly Hills, king of the junk bond market. And Ivan Boesky, merger arbitrageur extraordinaire and coiner of the “greed is good” mantra later immortalized by his fictitious avatar Gordon Gekko in the 1987 movie “Wall Street” (by which time Boesky himself was cooling his heels in the Lompoc Federal Correction Institution for a three-year term after being convicted of insider trading).

The Original Dr. Doom

The name Henry Kaufman may not ring a bell among many folks today, but back in the Roaring Eighties he was up there in the Valhalla of financial markets personages (and, unlike Milken, Boesky et al, never to be found on the wrong side of the law). Kaufman, a managing director at erstwhile bond market behemoth Salomon Brothers, was the original Dr. Doom – a nom de guerre now generally associated with the often dour economist Nouriel Roubini – and the de facto leader of a posse known as the “bond vigilantes.” Kaufman and his fellow vigilantes had a dour view of US fiscal policy, which they saw as beset by out of control spending and a bond market irresponsibly awash in public debt.

The bond vigilantes could move both stock and bond markets merely by pronouncing a view on where interest rates were headed. In perhaps the most famous of these pronouncements, Kaufman’s observation in August 1982 that interest rates were headed down for the foreseeable future sparked a stock market rally that lasted until the early 2000s. The influence of the vigilantes continued into the next decade, enough so to cause Democratic strategist James Carville to remark, early in Bill Clinton’s presidency, that he would like to be “reborn as the bond market” given how much sway it had over the economy and life in general.

Warning Shots and Dry Powder

It should not come as a surprise to anyone looking at charts of US public debt today to learn that the bond vigilantes are back. Total public debt is currently around 121 percent of US Gross Domestic Product, more than twice the level it was during the early 1990s when the bond vigilantes were terrorizing poor James Carville. Last September, when the Fed commenced its monetary easing program with a 0.5 percent cut in the Fed funds rate, Treasury bond yields rose, a counterintuitive movement reflecting, among other things, concern about debt, the deficit and whether inflation was really under enough control to continue cutting rates. That concern continued through the fall as inflation stubbornly moved sideways rather than down, eventually causing the Fed itself to revise its earlier thinking and signal a likely pause in the easing program. The vigilantes had spoken.

Yields continued to rise through the first couple weeks of January as additional concerns percolated about the inflationary potential of tariffs and sharp immigration restrictions with the arrival of the new government. Since then, though, the upward trend has tapered off. The 10-year yield today is around 0.2 percent lower than where it was on January 15. But that doesn’t mean the bond vigilantes have gone away. They are holding fire, keeping their powder dry but watching what will, and will not, happen with regard to campaign rhetoric becoming actual policy. A sustained upward trend in interest rates would create a world of economic problems for households, where credit card delinquencies are at their highest level since 2010, or among smaller businesses that rely on variable-rate credit instruments for much of their external financing needs. Government policymakers would be wise to channel their inner Carvilles and respect the sway of the vigilantes.

It is never easy to predict what is going to happen in the next twelve months, and very rarely do the best efforts of economists, sociologists and market pundits of all stripes get it all right (you can generally toss away all those specific numbers the big banks and securities firms come up with about where the S&P 500 or Nikkei 225 will be come New Year’s Eve 2025, and they will all be revised multiple times anyway between now and then).

It is especially hard this year, because the world is in a profound state of transition. What we have more or less accepted as the norms of what is still quaintly called the “postwar order” – the war in question having ended eighty years ago in 1945 – no longer seem to be the permanent backdrop for the shorter-term cycles of economic, social and political ebbs and flows. Nor is there anything like a clear-cut “new order” in anyone’s line of sight; what we are going through instead is a transition on many levels.

There is a lot going on in China right now. Talk of punitive tariffs against the Middle Kingdom swirled through the halls of Congress during a week of hearings for cabinet nominees. China’s trade surplus with the rest of the world hit an all-time high of $992 billion, probably giving even more grist to the tough-tariff mill. Its population fell by 1.4 million souls, declining for a third year in a row. Though China did, apparently, manage to gain several hundred thousand-odd virtual humans as TikTok aficionados the world over, in a fit of pique over the potential loss of their beloved app from which all mercies flow, signed up for Chinese social media start-up Xiaohongshu, which means “Little Red Book” and no doubt fewer than one percent of all those newbies signing up for the service will have a sense of the dark historical context of the Little Red Book. Let a thousand flowers bloom, in online spaces the world over.

Despite all the actual and potential headwinds, though, China has had a spate of good economic data to start off the year. Fourth quarter GDP growth came in at 5.4 percent year-on-year, higher than the 4.9 percent economists had expected. December industrial output rose 6.2 percent, and retail sales were up by 3.7 percent, both numbers beating consensus estimates. The National Bureau of Statistics (not known for being one of the more straight-up statistical agencies in the world) attributed the strong performance to the bevy of stimulus measures implemented last September to jump-start the economy.

Stimulus, Or Front-Loading?

Another, possibly more likely explanation for the strong showing is that Chinese companies have been front-loading exports, ahead of fears that those tariffs will come into effect sooner rather than later. That could imply a reversal that slows growth later in the year. Plus, of course, the actual impact of tariffs and other sanctions won’t be known until the rhetoric turns into actual policy. Which may be as soon as next week, or not until the second half of the year.

But even before the new administration takes office, the first two weeks of the year have seen a handful of other measures taken against China by the outgoing Biden administration. A start-up for developing large language modules for artificial intelligence called Zhipu was blacklisted by Washington, citing national security grounds. The administration is also imposing a wide range of export controls on US-made chips used for artificial intelligence. The EU is also getting in on the act, threatening Chinese medical device makers with curbs on access to European markets.

Deflation Trap Still Looms

Arguably, though, the biggest economic problem China still faces is the threat of deflation. The Consumer Price Index for China is currently 0.1 percent year-on-year. To put that into context, consumer prices in the US rose 0.4 percent just in the month of December alone. Economists think it will take considerably more stimulus than the measures Beijing implemented last September to pull the consumer sector of the economy out of its prolonged funk.

All things considered, we would prefer to see an economically healthy China to a troubled one, as we believe that will be a better recipe for global stability (and this year, anything that can add to stability will be welcome in our book). This first batch of upbeat headline numbers represents a good start. But there is still a very long way to go.