January 31, 2025

Welcome to Aurora Macro Fridays, your weekly overview of what matters most in global macro. Today's theme is success.

0. Week 2 Recap

• The week ending today was one of the heaviest macro newsflow weeks I can remember. Here is a quick recap.
• On Sunday, President Donald Trump went nuclear on Colombia, threatening not only tariffs but also financial and banking sanctions and visa cancellations--all over a dispute over the type of deportation flights the country would accept. Colombia relented almost immediately, and most of the measures never went into effect. 
• On Monday, the tech world was hit by Deepseek--a Chinese AI chatbot that promises to undercut Western competitors--NVDA lost something like 16% of its value at the open, which is a lot when you're valued at $3.6TN.
• On Tuesday, the White House almost caused a recession and constitutional mayhem by withholding funding that had already been appropriated to state and local authorities. The order was blocked by a judge right before it went into effect--it was later rescinded by the administration. 
• Internal link: On Wednesday, the Fed held interest rates and signaled a longer pause--read more about it in our piece Fed Update: Willful Ignorance. 
• Internal link: On Thursday, the ECB cut rates and signaled more to come. You can also read more about this in our piece ECB Update: Get On With It. Disappointing EU and somewhat disappointing U.S. GDP data also came in.
• Today is Friday. As this is going to press Trump delayed the much-anticipated tariffs on Mexico and Canada.

1. What does Success Look Like?

• No one can accuse the Trump administration of a slow, careful, or calibrated start. The first week was punctuated by executive overreach, dramatic U-turns, bizarre claims about who is to blame for a mid-air collision in Washington, DC, as well as the more usual tariff threats against Mexico and Canada (now due March 1) and picking a fight with Jay Powell. 
• External link: This all looks haphazard and could well end in tears--higher rates, higher term premia, global retaliation against tariffs, more expensive oil, the dethronement of the U.S. dollar, which hedge fund Elliott warned about. 
• External link: But you don't need me to tell you all that--you can read all about it in the New York Times--they have a livestream of bad Trump news here.
• Instead, I thought I would write today's note on what success would look like--and how the main macro markets would respond. As usual, I will focus on the macro-significant aspects of policy.

2. Success Means Lower Rates -- and Lower Growth

• To define success, we need to find a benchmark, and I think the 10-year Treasury rate is a good benchmark for our purposes. 
• High rates are clearly one of America's biggest problems. At 4.4%, the 7-year nominal rate (which is a rough proxy for where the U.S. should be borrowing) is higher than any other developed economy. 
• It should be no news to anyone that the U.S. has a federal deficit/public debt problem, and higher interest rates tend to make these problems harder. (see chart above)
• But high rates are also a problem for the private economy: they mean a higher cost of borrowing and higher mortgage rates.
• So how do we get there? In my view, fiscal consolidation is the sine qua non. Limiting the scope and breadth of tariffs will also help. 
• On the fiscal front, the infamous OMB memo would obviously have been contractionary had it been implemented: it basically shut off all federal funding in the United States. If it remained in force for its intended 90 days, it would probably have caused a recession. 
• External link: I doubt this is the right way to go about it, and so did a bunch of Republican senators, including the chair of the Senate Appropriations Committee.
• But perhaps the senators' time would be very well spent figuring out what changes can actually be made to make the coming reconciliation bill contractionary--meaning a lower deficit and, almost mechanically, lower growth.
• Lower deficit and lower growth is not a popular political rallying cry. But it is, arguably, what America needs to get its debt problem under control. 
• But is it feasible? Perhaps. I would watch the House Freedom Caucus, starting with Chip Roy (R-TX) who this week skipped the Republican "retreat" in Florida saying he would not "spend $2,000 to hear more excuses for increasing deficits."
• External link: The House is more interesting than the Senate in this regard, because the majority is far slimmer.
• So counterintuitively, I think success for the administration would mean a drastically pared-down reconciliation bill, leading to lower growth and lower rates across the curve. This would set the stage for more sustainable (and less government-dependent) growth later on in Trump's term. 
• If this sounds crazy, consider the alternative: a Treasury fight with bond vigilantes, a White House fight with the Fed, and ratcheting mortgage rates of the type we saw in the mid 1970s. 
• Currencies after the fold.

3. A Lower Dollar

• Trade policy has been a key concern of this administration from its first day in the office. 
• This is counterintuitive from a domestic economic perspective--after all, the U.S. just doesn't trade that much with the world--the joke goes that country is a "large closed economy."
• Its exports are something like 11% of GDP, its imports 14% of GDP, and the gap takes 3% off. 
• By contrast, China's exports are 20% of GDP, Japan 22%, and the EU 22.5%.
• But the U.S. is not just a very large self-sufficient economy. It is also the global rule-setter, the issuer of the reserve currency, and World Police more generally. 
• And although trade is relatively irrelevant to the U.S. economy, trade with the U.S. is very much relevant for smaller economies around the world. 
• So the administration has decided to use trade policy aggressively to get its way with international partners. 
• Internal link: We talked about all this with our resident expert Dmitry Grozoubinski in our conference call last month--you can find a replay here.
• But now we have action, with Colombia having been the first target and Canada and Mexico coming next. 
• What did we learn from last week's episode? First, that trade policy is being deployed to support domestic policies, in this case repatriation flights. That's not necessarily a bad thing--as these are easy things for other countries to cave on and for everyone to move on with their lives. 
• For Canada and Mexico, Trump has identified fentanyl and illegal immigration flows as the culprit. Again, these are laudable social policy goals--most people dislike transnational crime, deadly synthetic drugs, and uncontrolled migration. 
• So if the Colombia playbook can apply as well, maybe Canada and Mexico can agree to spend some more time and money securing their border and international trade can continue. 
• In other words, the key for tariffs to be successful is that they never have to be used--at least not against economies with which the U.S. is deeply integrated. 
• Which brings us to the key contradiction in how the Trump trade policy is working. Up until now we have had the threat of tariffs without any actual tariffs. The result has been dollar appreciation--making foreign goods more attractive relative to domestic ones and thus nudging up imports. 
• Even worse, the threat of tariffs has forced companies to import in advance, leading to a sharp deterioration in the trade balance. In December, the U.S. imported a net $122BN in goods--its worst number ever. 
• What can the administration do? It is hard to roll back on tariffs this late--it would look like capitulation and be tantamount to giving up all the international leverage this administration has built up.
• A better solution would be the so-called Mar-a-Lago accord that various economists have proposed--a reference to the Plaza Accord which caused a global rebalancing in FX rates. 
• As I mentioned last week, I think such an accord is both feasible and desirable for most trading partners. If the Trump administration were to tie tariff reductions to being a member of the accord, most developed economies would come to the table. 
• China would remain a key question, but China is also the primary reason we are having this discussion--it is hard for the U.S. to accept the world's largest economy having a closed capital account but unfettered access to global markets. 
• So in my mind, the metric of success here would not be higher tariff revenue, or a lower trade deficit--it would be a lower dollar leading a wider rebalancing in international trade--as well as providing a forum for the world's democracies to deal with the rise of China as an economic superpower. 
• In my mind, this would top off the "benign" scenario for how the U.S. economy develops: lower growth, lower rates across the board and a cheaper dollar. Perhaps it's not the base case--but it is a case well worth considering as an alternative to the dominant "trainwreck" narrative (higher rates, higher inflation, higher USD, sharp reversion in equities).

• Next week in the U.S: Another big week in the U.S. with December JOLTS on Tuesday and January Payrolls, Unemployment Rate and Michigan on Friday.
• Other releases include January ISM Manufacturing PMI on Monday, December Trade data and January ISM Services PMI on Wednesday, 4Q24 Productivity and Unit Labor Costs on Thursday, and January Hourly Earnings on Friday.
• Fed Speakers include Musalem, Jefferson, Goolsbee, Bowman, Waller, and Kugler. Non-voters include Bostic, Daly, and Barkin.
• Next week in Europe: January Flash Inflation on Monday, December PPI on Wednesday, December Retail Sales and January Construction PMI on Thursday.
• ECB Speakers include Donnery, Lane, and Guindos.
 

Have a great weekend,

Disclaimer  

This newsletter is a general communication being provided for informational and educational purposes only. It is not designed to be a recommendation for any specific investment product, strategy, plan feature or other purposes. By receiving this communication, you agree with the intended purpose described above. Any examples used in this material are generic, hypothetical and for illustration purposes only. Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies described may not be suitable for all investors.

None of Aurora Macro Strategies, LLC, its affiliates, or representatives is suggesting that the recipient or any other person take a specific course of action or any action at all. Prior to making any investment or financial decisions, an investor should seek individualized advice from personal financial, legal, tax and other professionals that consider all of the particular facts and circumstances of an investor's own situation. Neither Aurora Macro Strategies or any third party involved in or related to the computing or compiling of the data makes any express or implied warranties, representations or guarantees concerning information or perspectives included in written research. In no event will Aurora Macro Strategies or any third party have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) relating to any use of this information.

This report has been created without regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Company fundamentals and earnings may be mentioned occasionally but should not be construed as a recommendation to buy, sell, or hold the company’s stock. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security--including mutual funds, futures contracts, and exchange traded funds, or any similar instruments.

The text, images, and other materials contained or displayed on any Aurora Macro Strategies, LLC product, service, report, email, or website are proprietary to Aurora Macro Strategies, LLC and constitute valuable intellectual property. No material from any part of www.auroramacro.com may be downloaded, transmitted, broadcast, transferred, assigned, reproduced or in any other way used or otherwise disseminated in any form to any person or entity, without the explicit written consent of Aurora Macro Strategies, LLC. All unauthorized reproduction or other use of material from Aurora Macro Strategies, LLC shall be deemed willful infringement(s) of this copyright and other proprietary and intellectual property rights, including but not limited to, rights of privacy. Aurora Macro Strategies, LLC expressly reserves all rights in connection with its intellectual property, including without limitation the right to block the transfer of its products and services and/or to track usage thereof, through electronic tracking technology, and all other lawful means, now known or hereafter devised. Aurora Macro Strategies, LLC reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of its rights.

The recipient should check any email and any attachments for the presence of viruses. Aurora Macro Strategies, LLC accepts no liability for any damage caused by any virus transmitted by this company’s electronic communications.