Bend or Break?

The market is seesawing back and forth like a ship in a typhoon with every new missive on sanctions, tariffs, and funding cuts giving investors queasy stomachs. As we have maintained for months, day-to-day price action has little meaning, and looking at longer horizons is more important. Consensus is more concerned with a growth slowdown than inflation at the moment. Best not to lean too far over, port, or starboard.

Pray for Poor Judgement

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It’s starting to feel like Y2K all over again as anxiety about the calendar is mounting with the upcoming April 2 tariff rollout. Hopefully, investors believe the worst is already discounted and are not fearful. In a world led by the tail of optionality, “See No Evil” is the best setup to keep selloffs contained.

However, if fear is still the prevailing currency and market participants have pre-emptively insulated their portfolios through buying downside protection, the markets could be vulnerable. When investors have prepared in advance by buying puts, that creates conditions for a large breakdown because the banks that sell them insurance deepen the selloff by being forced to sell into a stock decline. If institutions buy VIX calls to insulate their portfolio from a sharp drop, then a spike in VIX will have options desks, who are short those calls, scrambling to buy VIX futures, pushing the VIX volatility index even higher.

One of Pave’s founders used to run derivative trading groups, so we are all too familiar with a negative gamma position turning against a bank’s book. If that happens, markets can get hectic, because Commodity Trading Advisors’ systems react by flipping short, target volatility funds reduce their gross holdings more aggressively as price ranges widen, and now, with the emergence of leveraged ETFs, there is yet another dimension of selling. This forces options desks to sell even more heavily to minimize their losses, and the descending cycle accelerates.

Used Cars: A Study in Supply Disruption

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President Trump’s imposition of 25% tariffs on autos does fulfill his longing for the past, but it’s the wrong past. His actions will slow down new car sales after the current inventory is depleted, bringing back the inflationary supply chain headaches of 2020. Increased new car prices will drop sales, leading to a shortage of used cars and driving up used car prices. We have discussed how tariffs produce supply chain problems that drive up prices across many products, but unlike 2020, where stimulus checks helped the U.S consumer, there will be no fiscal boost this time. The supply chain contraction in 2020 that caused the initial inflation spike in used cars (not to mention repair and insurance costs) was relatively brief, but there was a long adjustment period that pushed inflation higher into Q1 2023. We expect a similar dynamic.

Looking at the Personal Consumption Expenditure Price Index, Core Goods PCE was negative throughout 2024, pulled down by a string of falling used cars prices dating back over two years. Used car prices just moved into positive territory, registering a 0.75% inflation rate in February. It is no coincidence that Core Goods inflation has also just turned positive. Fed officials are worried about rising core goods inflation because it had capped overall inflation readings.

A rise in core goods while services inflation remains sticky will stop any downward momentum for inflation reaching its 2% objective. In the March Summary of Economic Projections, only three Fed committee members expected core PCE inflation to exceed 3% by year-end. Significant jumps in used car prices could see several Fed members forecasting 3% inflation, resulting in no rate cuts this year, an unwelcome event for markets.

MAGA…or MCGA?

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As we look back on Q1 2025, it is possible we are creating a more level playing field, but only in the sense of raising our trading partners up to us. We have discussed how Europe and China will be long term beneficiaries of a misguided U.S. tariff policy. Add Canada to that list. On Tuesday, the newly minted Canadian Prime Minister Mark Carney announced plans to “deliver an unprecedented acceleration of investment in our armed forces.” He gave an important speech that unfortunately may be ignored in Washington: Carney mentioned possibly pulling military contracts from the U.S. such as American F-35s and discussed new domestic investment and production to replace Canada’s reliance on American military exports. What he described is the opposite of President Trump’s expectation that tariffs will create more U.S. jobs. Carney said he will look out for Canadians, and “be more Canadian in our decisions.” Sounds a bit like a Canada First policy?

The prime minister expects to negotiate from a position of strength and they “are not rushing to the table to take something.” There is a multi-faceted response in place: retaliatory tariff revenues will be directed toward unemployment insurance for workers and fund subsidies for agriculture, steel, and aluminum sectors. Taxes will be deferred for firms, and Carney’s administration has prepared a schedule of goods that they can add to existing retaliatory tariffs depending on the severity of the April 2 tariff decree. There are further measures to increase economic efficiency, such as reducing barriers to worker mobility between provinces.

The governments of those countries targeted by the U.S are focusing on stimulating domestic demand to diminish their reliance on exports. Germany‘s new infrastructure spending plan is expected to add 1% annually to their GDP over the next decade. This fiscal expansion is in addition to lifting their debt limit so they can vastly increase military expenditures. Because Germany’s current account surplus is over 250 billion Euros, those excess savings will likely shift from U.S. Treasury bond purchases toward funding their own fiscal deficit. Expect lower global demand for Treasuries that pushes up U.S. yields, making it more difficult for American consumers and corporations to prosper.

What to Look for This Week

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(All times D.S.T.)

1. Aside from the major announcement on April 2, Friday, April 4 at 8:30 a.m. marks the March Nonfarm Payroll report. The headline consensus is low at 80,000, but our attention is on Private Average Weekly Hours, which has been at 34.1 for January and February, matching the March 2020 pandemic low and a level normally associated with recessions.

2. Tuesday, April 1 at 10:00 a.m. Job Openings and Labor Turnover Survey JOLTS for February. We will, as usual, ignore the headline and look at the Hires and Quits rates (emphasis on Hires). Any downtick in either will be negative. Thursday, April 3 at 10:00 a.m. is March ISM Services PMI. Focus on Employment: except for August 2023, February’s 53.9 Services Employment was the highest in 4 years.

3. Wednesday, April 2 at 9:45 p.m. is the Caixin March Composite PMI for China. It is forecast to come in slightly below February’s 51.5, but given the recent stimulus out of Beijing, we are looking for any upside surprise given the bullish tone in Chinese stocks.

FOMC Voters Speaking: Chair Powell gives a keynote address Friday, April 4 at 11:25 a.m. and could be of note since it is 3 hours after the Nonfarm Payroll number. Nothing else on the slate next week of note. Perhaps there will be some leaks to the press after the tariff announcement.  

 Royal Bank of Australia rate decision Tuesday, April 1 at 12:30 a.m. The RBA cut 25 basis points at their last meeting in February.

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