Markets Need More Than Rate-Cuts To Recover

Authored by Daniel Lacalle,

The consensus narrative tells you that markets are weak because of Trump’s tariffs. However, that is a typical excuse that makes no sense. If tariffs were the cause of concern, markets would have tanked in 2016 and in 2021. Remember that Biden maintained and increased all of Trump’s tariffs. Between 2016 and 2024, the tariffs imposed by the European Union and China on the United States were much larger than levies against them. However, you never read or heard that the EU and China tariffs were going to destroy the economy or lead to massive inflation.

The mainstream consensus narrative always wants you to believe that tariffs are fine if imposed by socialist countries and evil if imposed by the United States. However, if the market was alarmed by tariffs and the disastrous impact they may have on the economy, German and Japanese bond yields would not have soared. Instead, they would have plummeted as investors sought refuge. Furthermore, if the world feared a US economic disaster, Treasury bond yields would not have declined.

German and Japanese bond yields would be declining and US yields rising if that were the case. What is happening is the opposite. The German 10-year bond yield has risen 21% in 2025, and the Japanese equivalent has soared 34%. The US 10-year Treasury yield has declined 5.6%.

What is really going on? Many market participants are addicted to money printing and dovish central banks. In fact, two generations of traders have only seen rising debt, liquidity injections, and negative real rates, which helped justify increasingly demanding equity and risk asset price valuations. Thus, the market greeted bad economic data with optimism, anticipating another round of monetary laughing gas.

The reason why markets are so volatile is because few know what to do when inflation remains persistent. The Fed panicked twice in 2024 and conducted a misguided dovish policy. It delayed the reduction of the balance sheet in June despite rising inflation expectations and loose financial conditions. In September, the Fed decided to implement an unjustified large rate cut despite concerning core inflation figures and exceedingly loose financial conditions, the loosest in five years. The Fed’s excessive optimism about the disinflation path led to a significant increase in margin debt and exposure to equity markets.

Consensus estimates assumed three or four rate cuts in 2025. However, in November the Fed went hawkish and started to worry about a persistent inflation that was already evident in its previous two dovish moves. Markets did not care and continued to believe that inflation would drop magically despite soaring deficit spending and record debt as well as the highest money supply growth in twenty months. By January, market participants started to worry about persistent inflation. The Fed decided to be serious about inflation and provide hawkish messages coinciding with the end of elections.

Were you not surprised to see how the Fed was unusually dovish and optimistic throughout the campaign and elections and suddenly went hawkish and tightened monetary policy once the new administration entered into office? “Higher for longer” was halted, surprisingly, in the middle of an election, and now it is back. Shocker. Meanwhile, the ECB and China’s PBOC are conducting easing policies.

Why are markets rising in Europe and falling in the United States? Not because of tariffs. If that were the case, bonds would have risen in Germany and Japan, and the stocks that benefit from those tariffs would have risen. The answer is simpler: market participants are betting on a hawkish Fed and a very dovish ECB and PBOC.

Follow the money printer. Many market participants are scared of persistent inflation but aim capital flows to the markets that may benefit from more money printing, as is the European case, and stimulus plans, like China. However, this is a dangerous bet. Betting on European markets due to a massive spending and easing plan is not new. We have seen it before. Central planning never works and the disappointments that follow are enormous. This time is not different. It will not be different with China either, because its overcapacity and real estate challenges come from previous “stimulus” plans.

Market participants in the United States may be used to insane spending, debt, and printing as the reasons to buy. However, the situation for the US economy was unsustainable. If the administration does not cut the deficit and the excesses of the public sector, the stagflation risk we have discussed numerous times will be a reality.

The United States administration has to do what is necessary to curb its fiscal imbalances and do it quickly, because the situation is not just unsustainable from a fiscal perspective but also a danger to the US dollar.

Market participants will need more than rate cuts. We need to see real rates falling, inflation under control, and the deficit slashed. The Fed’s policy mistake happened in 2024. They have created the current turmoil. Investing needs to be focused on real fundamentals and less on following the money printers, because the problem of monetary destruction is much larger than the alleged benefits of multiple expansion.