Bessent gets his wish, but not in a good way

Treasury Secretary Scott Bessent recently declared that the Trump Administration was mainly focused on lower the 10-year Treasury yield. He seems to be accomplishing his goals. Yields are moderating, and the MOVE Index, which measures bond market volatility, is relatively tame. He is achieving his objective, but at a price – by tanking the economy.

 

 

Fragile and unbalanced growth

A recent WSJ article revealed that the top 10% of Americans account for about half of all consumer spending. The cumulative excess savings of this group rose and remained steady in the wake of massive fiscal and monetary COVID-era stimulus. By contrast, excess saves of the other 90% have declined.

In other words, the U.S. economy now depends on the high-end consumer, which makes for highly fragile and unbalanced growth. Here’s a case in point. Walmart, whose sales are more exposed to the lower income consumer, described the consumer as resilient during its earnings call, but with the caveat that “we’re seeing higher engagement across income cohorts, with upper-income households continuing to account for the majority of share gains”.

 

Such an uneven distribution makes growth increasingly reliant on further gains in the wealth effect in the form of rising equity and property prices. Since the top 10% owns most of the wealth in the U.S., this makes the economy highly vulnerable to shocks in asset prices from a negative wealth effect.
 

 

Here are the risks. I have already extensively documented how the valuation of the S&P 500 is stretched by historical standards. Here is a compilation of valuation metrics from Mark Hulbert showing the S&P 500 is wildly overvalued by historical standards.
 

 

In the face of elevated valuation, some worrisome developments are appearing. While the House budget blueprint passed last week may be regarded as constructive inasmuch as it proposes to extend the TCJA tax cuts, the tax cut extensions represent the status quo and they are not fiscally stimulative. On the other hand, the extension was accompanied by significant cuts of $1.5–$2 trillion to the budget, which is a form of fiscal contraction and therefore equity bearish. The cuts are the equivalent of a tax increase to the lower income cohorts, which will restrain growth. To be sure, the budget blueprint will take time to become law as the legislation winds its way through the Senate, followed by a reconciliation process. Nevertheless, the fiscal plan, as presented, represents an unwelcome fiscal contraction that is equity negative.

Notwithstanding the budget developments, there is already growing evidence of a deceleration in the growth outlook. The Economic Surprise Index, which measures whether economic releases are beating or missing expectations, has fallen into negative territory.
 

 

The jobs market is also softening. The continuing message from successive JOLTS reports tells the story that it’s increasingly difficult to find a job. Leading indicators of employment, such as temporary jobs (blue line) and the quits/layoffs ratio (red line), are declining.
 

 

The above data does not include the DOGE layoffs, which will become evident in the March Payroll Report. Estimates of federal government employment show that there are 2–3 government contractors to every government employee, so the scale of the job loss may be worse. In addition, state and local government employment has been contracting.

Bloomberg Economics modeled the effects of DOGE cuts under differing scenarios and projects the peak effects would be seen in H1/26. All else being equal, GDP growth slows, unemployment rises, inflation falls and the Fed cuts more than what the market is currently expecting.

Mission accomplished, as measured by the 10-year Treasury yield, but falling growth will be bearish for stock prices.
 

 

 

Uncertainty = Weak capex and hiring

Business uncertainty is also rising. The Dallas Fed Survey of businesses provided a fascinating window into growing concerns over tariffs and other Trump policies, which will hinder capital expenditure and hiring plans. Here are some selected responses:

Chemical Manufacturing: “Tariff threats and uncertainty are extremely disruptive.”
Food Manufacturing: “The current political environment under President Trump has increased the uncertainty of the consumer market. As a food manufacturer, we have noticed small customers are struggling (unable to pay bills on time), and the larger national customers have reduced their purchases. Imposing tariffs on our major trading partners will lead to higher consumer prices…Immigration laws and raids [are affecting our business].”
Miscellaneous Manufacturing: “The uncertainty in tariff threats and general chaos of another Trump presidency is weighing heavy on our business. All customers are decreasing or pushing out orders—taking a wait-and-see posture.”
Non-metallic Mineral Product Manufacturing: “It is very hard to plan. Interest rates? Tariffs? Wow.”
Printing and Related Support Activities: “I’m very worried about the possible tariffs affecting some of our material costs, which we will have no choice but to pass along to our customers.”
Transportation Equipment Manufacturing: “The new tariffs will have a big impact on the demand for our products. This applies primarily to the 25 percent on goods from Mexico. The impact of the additional 25 percent for steel and aluminum will also be detrimental to demand, the extent of which is still being evaluated.”

Unrelated to the business survey, the Dallas Fed Manufacturing Index also came in below expectations: new orders; production; shipments; and employment were all weak.