Monday Macro – Pulling together some big-picture thoughts
How three big structural trends might impact your investments
This week's big story is obviously President Trump's inauguration and the likely blizzard of policy announcements. What he and his team have in mind is beyond my purview – we’ll have to wait for his campaign of shock and awe.
Over the next few weeks, I’ll attempt to parse what impact these developments might have on investment decision-making, helped along, I am sure, by copious research and strategy notes from the big institutions.
By contrast, this week, I want to gather observations on three big structural trends that appear frequently in these letters: the bond vigilantes and the yield strike, the power of the dollar and a broken trade system, and, last but by no means least, the dilemmas posed by an ageing, shrinking society.
I’ll try to ‘weave’—to use a Trumpian favourite term—this together by avoiding a scattergun of charts and quotes. The point is to outline instead a straightforward narrative that, to me, at least makes sense. Crucially, though, these trends greatly impact most readers' investment portfolios.
The bond vigilantes and the yield strike
The big story of 2025 has been the rise in yields on long-dated government securities, which has been most pronounced in the US and the UK. This rise in yields on 10- and 30-year paper has spooked investors and prompted talk of a yield strike by bond vigilantes, i.e., bond investors won’t pay for massive government debt issuance unless the yield on offer is substantially higher.
The headline drivers are worries about inflation and the increase in the term premium, i.e. the extra yield paid to investors in long-dated bonds versus their short-dated equivalents. Lurking behind this yield strike – more yield or no money into Treasuries and Gilts – is the dawning realisation that the US economy has been growing so fast, partly because the US government has been running a huge deficit to pump prime the economy. As early as 2020, economists like Larry Summers were warning that this huge fiscal pump priming – started by Trump during Covid – would be inflationary, and so it has come to pass. Inflation rates peaked and then fell back, but the current metrics show no real sign of inflation in the US and the UK stabilising below 2%. Instead, we seem to be stabilising in a 2 to 4% range above where the central banks in both countries would like to be. In my book, that seems like an acceptable range for a modern economy, but I am not a central banker.
However, the bond vigilantes are also wise to another reality. They look at the long-term trajectory of government spending, especially in the US, and see even more demand for government largesse and ever more demands to cut taxes and help ‘the working man/woman’ with lower tax rates. There is only one long-term result: enormous government deficits. Overlay over this an ageing society (see below) and dramatically higher spending on healthcare and pensions, and we have a fiscal time bomb which already keeps economists and central bankers awake at night.
What makes matters even worse is that bond investors also know that a bigger government doesn’t increase satisfaction with government services. Quite the opposite in fact. The more money big government seems to spend, the worse the perception of many voters, i.e., a credibility gap exists. One way of squaring this is to spend MORE money to improve services – a strategy currently underway in the UK. This may or may not achieve its objective of restoring trust in public services. Still, bond investors rightly spot a trend developing – spending more government money to provide more resilience to fearful voters, making those deficits even greater!
So, in the round, add it all up: no great enthusiasm to tax voters more, more demand for public services, an ageing society, politicians unwilling to do unpopular things in a populist age, fiscal spending in the US pouring petrol on the flames of an already ‘hot’ economy (and Uk governments also increasing public spending), more defence spending in a newly multi-polar world, and you have the perfect storm. Combine that with a market with lots of debt issuance, and you have a situation where oversupply meets fearful demand. The net result is higher yields.
Personally, I see no way out of this fix without what some economists have called a new age of austerity. This means drastic cuts in government spending, an attempt to dampen international conflict to avoid costly escalations in geopolitics, probable tax rises (mostly landing on wealthier investors – an argument even Steve Bannon is making) and more taxes on capital. This might be combined with tax cuts for working folks as an attempt to kickstart growth, combined with more revenue from tariffs (though I have severe doubts the revenues will be that great), but the net impact will be deflationary in the end. Markets have not priced in this possibility.
If governments don’t choose this austerity path, then we are simply delaying an inevitable crisis at some point in the future. If deficits keep rising inexorably, there will be a bond buyers strike, and we’ll see a maxi Truss-like episode, possibly even hitting the US economy.
The bottom line is that most developed world governments live beyond their means, especially in economies with low growth and productivity growth rates (the UK). This also suggests a higher new interest rate order for longer unless austerity brings down debt levels. One factor to watch out for on the upside is if AI permanently pushes the growth rate higher, which would get governments out of the hole: growth would pick up, revenues would increase, and governments would reduce their deficits. The alternative is to inflate away debts and hope central bankers don’t over react with punitive interest rate hikes.
The power of the dollar and a broken trade system
It doesn’t take a genius to spot that the current global financial and trade system has a major flaw. A handful of economies led by the US (and the UK) run up huge trade (and fiscal) deficits and act as consumers of choice for economies such as China, Japan, Vietnam and Germany.
China has become the manufacturing hub of a vast Asiatic industrial complex. This has happened not because the Chinese communists have dictated it but because China is damned good at manufacturing things. Its leaders have also decided to move up the value chain and compete aggressively in higher margin, higher value-added goods such as cars – which are now flooding western markets and threatening to wipe out domestic manufacturing sectors.
This huge imbalance is sustained by a financial system in which the US provides massive and ample liquidity—partly via its deep bond markets—which help fund these trade and capital flows. Dollars flow back to China and other countries, which choose to invest some (though not all) in US Treasuries and, to a lesser degree, US equities.
This compact worked for a long time, but it is clearly breaking down. Western politicians have received a message from voters that they hate the collapse of their domestic manufacturing sector and want something done about it (though that something might mean more expensive imports). Also, more pertinently, policymakers have rightly spotted that the Chinese leadership is not taking a benign view of this relationship with the West. China increasingly sees itself as an adversary of the Western order – and has stated so publicly – and thus, the West has built a dependent supply relationship with what many perceive as a hostile power.
China also has its problems, of course. It's exporting deflation, and its domestic consumer market is broken and lacking confidence. Covid seems to have had a cataclysmic impact on consumer confidence, and the property market is still, three years on, spiralling into deflation. Its rulers are also keen to wait and see what Trump might do to the Chinese economy, and thus, they will be loathed to over-commit to any reflationary policies. More worrying is that its leaders don’t seem willing to embrace the age of big government with respect to welfare policies, i.e., underwriting a massive expansion of support for its citizens. They prefer to spend money on R & D, the military and generally increase industrial capacity.
The USA represents the other side of this vast trade and financial system. It’s allowed this imbalance to continue for decades because it is supremely successful in several key respects. It has an open economy, it has
· A deeply sophisticated financial system that has fixed most of the key plumbing issues (bar instant bank transfers),
· Open and efficient debt and stock markets that easily facilitate instant liquidity. Consider how easy it is to trade US equities versus UK equities
· It has above-average corporate governance, although CEOs are allowed to get away with murder by their supine boards
· It boasts some leading cutting-edge sectors, not least the tech sector
· Its government is willing to defend its key industries with interventionist policies
· Its soft business culture emphasises respect for laws and an intensely legalistic way of conducting business
· All in all, a winning combination of open markets, corporate governance (and respect for the law) and technological efficiency
· Oh yes, and its government has pump-primed the economy and its economy now boasts above-average growth
· Last but by no means least it has a vast military complex that can defend its financial interests
I always think that at this point, it's useful to compare the USA to two other key financial markets that might also attract external capital inflows: Japan and the UK. Japan boasts fabulous companies in all the right sectors (robotics and industrials), a strong legalistic culture, responsible but interventionist governments and robust debt markets. However, corporate governance remains poor, economic growth is anaemic, and stock markets are not wired for a digital age (try investing in Japanese equities). As for its military might, the less said about that the better (although it is improving).
As for the UK, we have open markets, excellent corporate governance, a wonderful legal system, relatively stable government, OKish economic growth, very efficient debt markets but a dreadful mix of sectors which excites no one, and a military that couldn’t defend us after two weeks.
Which country would you choose to focus your investment flows on?
The net effect is that the US dollar keeps getting stronger on a trade-weighted basis and global investors keep pumping their capital into US debt and equity markets. That, in turn, makes global investors fearful of missing out, or FOMO, which in turn produces a positive momentum effect. The dollar is also a safe haven in troubled times, and the stronger the dollar gets, the bigger the returns for foreign investors.
The snag here is that a stronger dollar doesn’t make US industries more price competitive (the opposite in fact), and it fuels calls by some politicians and economists for a new Bretton Woods agreement, i.e. capital controls and planned devaluations while fiscal deficits are tackled. For a long time, these radical calls were fobbed off. Still, I sense we are getting closer to an awkward conversational moment: why should the US keep funding the growth of political rivals while destroying its own industrial base? Thus, we have the reshoring debate, talk of tariffs, and more radical ideas.
An ageing society and a shrinking population
Most investors see the ageing society trend one-dimensionally – more opportunities from a society growing inexorably older. A more nuanced analysis would start by looking at the flip side of an ageing society – a declining population. In my view, collapsing fertility rates and negative population growth in countries like Italy and Japan are just symptoms of an ageing society. We are mid way through a profound demographic transformation, and policymakers will be able to do very little to halt these trends. All the talk of pro-natalist policy mixes is just hot air in my view: younger people increasingly don’t want to have more kids because having kids is really expensive in an ageing society where housing costs are escalating out of control. Every single pro-natalist policy will face the obstacle of financial common sense – kids are expensive and getting ever more so.
Younger citizens are also keenly aware of all the trends that animate bond investors. They know that longevity in most countries is increasing, that next-generation anti-obesity drugs will dramatically improve health outcomes, that new drugs for dementia and Alzheimer's are on their way, and that all this costs money, money that will find its way into younger people’s tax bills. Again, faced with ever higher tax bills and increasing retirement ages, why focus on having kids? Undoubtedly, the focus will be on finding enough money to pay for a house or a flat, i.e. postpone marriage, stay at home longer, delay kids, or even not have kids. Layer over that AI and the coming tech revolution, which demands ever more time for younger eyeballs, and one wonders where younger people will find the time to have kids.
In economics, this trend of an ageing society (and contracting population) has sparked a fascinating debate about its macroeconomic impact. One relatively uncontroversial area of consensus is that productivity growth rates, already low, might slow even further (the subject of a recent IMF paper) unless AI kicks in.
A more contested debate is between economists like Charles Goodhart, who argue that an ageing society is inflationary, and those who reckon it's deflationary. I can see arguments for both camps.
Charles Goodhart and co-author Manoj Pradhan argue in their book "The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival" that the key variable will be the changing dependency ratio in ageing societies. As populations age, the proportion of dependents (retirees and elderly) increases relative to the working-age population. This shift is inflationary because:
· Dependents consume more than they produce, while workers produce more than they consume.
· The elderly tend to spend a larger portion of their income rather than saving it, increasing overall economic consumption.
I would add that an ageing society might also see a renewed focus on the property market and increased house price inflation, considerable increases in home rental prices, and massive increases in spending on healthcare – a sector with notoriously poor productivity growth rates and endemic cost-push inflation.
Quite how these trends play out is up for debate, and I think we can all see a bit of both arguments playing out in the data – I’m especially worried by the inflationary impact of the housing market. An older population will focus on preserving the value of their housing capital and obstruct any supply-side changes that will (negatively) impact the value of their housing investment (a perfectly rational reaction with dreadful long-term impacts). The net effect can already be seen in UK housing rental inflation, which is consistently above where the Bank of England would like it to be.
Investment Implications
Moving away from the policy debates and back to the investment implications, the combination of continued US financial hegemony, a strong dollar, higher rates for longer and an ageing society have some potential direct investment implications:
· Bond investors are not pricing the possibility of impending government austerity, potentially making the current high yields very attractive if the policy environment changes.
· Equity investors are also not pricing in the possibility of an age of austerity. This could knock corporate earnings very hard!
· Unless we see a new version of Bretton Woods or the Plaza Accord, we are likely to see the continued growth of flows into the US market, partly fuelled by FOMO and partly fuelled by that strong dollar
· Investors' overweight exposure to the US markets (and stocks) is likely to continue and may even get more pronounced – that makes a sensible diversification strategy even more important
· Many of these flows will be passive and driven by momentum, i.e. stock pickers will have a tough time beating the flow of funds into leading sectors
· By contrast, the impact of an ageing society will favour stock pickers on a bottom-up basis in individual country markets. I'm not sure a passive approach to picking stocks in an ageing and shrinking world makes sense. Sure, asset managers might benefit, as might biotech firms, but the devil is in the execution plan for these businesses.
· If the financial and trade system doesn’t change or re-order based on a new Bretton Woods or Plaza agreement, we are likely to face higher rates for longer environment, with the very real possibility that interest rates could actually go higher in 2026 if inflation picks up momentum again as the US fiscal deficit expands
· High positive real interest rates (interest rates above the long-term expected inflation rate) will choke economic growth, making corporate refinancing expensive
I’ll finish with three other trends that, I think, warrant a mention, even though I’m hugely uncertain about how they will play out:
The geopolitical environment. We are clearly moving away from a unipolar global political order to a multi-polar world where the US tends to distance itself from its old global hegemon role. Quite how this plays out is anyone’s guess, but I would wager that the net result will be more disorder and more defence spending
AI seems to be advancing rapidly and could have a seismic impact. I’ll return to this topic in next week's Monday Macro.
Lower productivity growth rates in the UK and Europe. Why the economies of the old world (Europe) are slowly growing in productivity is worthy of a huge debate, but the reality is apparent: Europe faces a mounting productivity challenge.