by Jurrien Timmer, Director of Global Macro, Fidelity Management & Research Company
V- Shaped Rocket Ship
The fastest recovery ever continued last week, with the S&P 500 index gaining another 2%. The $5 trillion Big Beautiful Bill (BBB) was passed, and it looks like the markets have re-priced in the animal spirits that were part of the red wave playbook last November, before they were un-priced in March. And so, the pendulum swings, back and forth.
With the end of the 90-day tariff reprieve looming, as well as the quarterly refunding statement and second quarter earnings season, we will soon find out what comes next. Renewed tariff pressure could push earnings estimates down, while the BBB could lift them up. Faster growth can keep the rising debt burden sustainable, unless the bond vigilantes push the term premium higher and bear-steepen the curve further. For now, the 10-year remains locked in its range, while the US dollar continues to lose ground. Many moving parts.
The first half of 2025 has been quite the rollercoaster for investors. Perhaps we will get a reprieve in the second half, but this being 2025, I wouldn’t bet on it.
Do You Want to be Long This Chart?
With month-end and quarter-end behind us, let’s take a look at some longer-term charts and ask ourselves “do I want to own this?” With the S&P 500 index making all-time highs once again, the trendline is clearly up and the index is now well above it. This shows momentum, which usually begets more momentum. The only thing not to like in the chart below is the tepid breadth, with only 57% of stocks above their 200-day moving average.
Earnings Bounce?
In terms of the fundamentals, the loss of earnings momentum that was priced in a few months ago as the Tariff Tantrum was raging will now be put to the test as Q2 earnings seasons gets going in another week, while the 90-day cooling off period comes to an end. Based on the historical pattern, 2nd quarter earnings growth could potentially improve 300-500 bps from the current 2.8%, which would bring us to the average long-term growth rate of 7%.
Earnings, the Dollar, and Financial Conditions
Barring another tariff tantrum there are reasons to expect earnings growth to improve from here. For one, the dollar index is down 8% year-over-year, which could help earnings growth re-accelerate.
Furthermore, with financial conditions loosening, earnings revisions (which are clearly correlated) could bounce as well. The new fiscal bill should also lift earnings, as well as capex.
Do You Still Want to be Long this Chart?
Getting the earnings right is only part of the puzzle, however. Knowing how much to pay for each dollar of earnings is as much art as science. Coming back to the “do you want to own this?” question from before, does the answer change when we add valuation to the mix? Do you want to own the chart below, knowing that you are paying almost 24 times expected earnings? It’s not a layup.
The Fed
While political pressure continues on the Fed, monetary policy remains on hold, which in my view is the correct approach. While there is room to cut rates (3 times, according to my math), there is really no hurry to do so. Monetary policy is not that restrictive, the US economy is less rate senstitve than it has been, and while the inflation rate continues to edge closer to the Fed’s target, it has been quite stubborn. The Fed is leaning into fiscal expansion, as it should.
Taylor Rule
With the joblss rate ticking down to 4.1% in June, while inflation expectations hold steady, there hasn’t been much progress from the Taylor Rule. If the neutral rate is around 100 bps (real) and inflation remains sticky at 2.5-3.0%, then a few rate cuts are all we might get.
Finally, while some softening is evident in the US economy, US GDP has continued to grow faster than its potential. Between a negative output gap and above-target inflation, there doesn’t seem to be any reason for monetary policy to be below the neutral rate.
Beware the Bond Vigilantes
Above all, a premature policy easing runs the risk of being challenged by the bond vigilantes, who can bear-steepen the curve and hit the economy where it really hurts.
Debt Sustainability
With the Big Beautiful Bill now law, and expected to add $5 trillion in debt, the question is whether the US economy’s speed limit can be raised enough to avoid a debt spiral down the road. The simple math is that the economy needs to grow faster than its cost of borrowing. That has generally been the case over the years, and when it wasn’t, the debt burden was too low to matter.
But as the debt burden grows larger, that differential between the 10-year yield and the long-term growth rate in GDP will become all-important. If the term premium rises to 150 bps (which seems reasonable to me, especially as the dollar loses some of its safe haven status), and the long-term growth rate in potential GDP slows to 4% (per the CBO’s forecast), the math will become more challenging, to the point where the Fed may have to step back in the markets and execute some version of Yield Curve Control (YCC). That’s fiscal dominance in a nutshell.
Fiscal Dominance & Gold
Perhaps gold has been eyeing a new era of fiscal dominance since 2022, when it stopped trading on real rates and started trading on the dollar’s eroding hegemony.
With the US dollar now comprising 54% of all reserve currencies and 58% of allocated reserves, gold’s share of all reserve assets has more than doubled since 2015, from 6% to 15%.
The chart below shows that gold has been taking market share from fiat reserves, including the Dollar and the Euro. In fact, gold has now become the second largest reserve asset behind the Dollar and just ahead the Euro.
Bitcoin
Bitcoin has been along for the ride, of course, and has been benefitting from both a rising global money supply and a rally in risk assets. A win-win for Dr. Jekyll and Mr. Hide.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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