February 6, 2025

QuickTakes

A Bond Vigilante

In Trump's Court

Trump 2.0 is borrowing a page from the Clinton administration's playbook, specifically the one in which Robert Rubin and James Carville warned Clinton that he had to respect the power of the Bond Vigilantes and maintain fiscal discipline. US Treasury Secretary Scott Bessent yesterday said that he and President Trump are less concerned with the federal funds rate (FFR) and instead are hoping to contain the 10-year Treasury yield. Bessent's message to the Bond Vigilantes was that he has explained to President Trump that they have the power to stymie his fiscal agenda.

That makes sense to us, especially since premature Fed rate cuts helped boost long-term yields, and therefore borrowing costs, over the past six months. The Bond Vigilantes protested the lack of monetary discipline.

A major component of the administration's economic plan is to bring down oil prices. As long as Trump 2.0 can increase oil supply enough to lower oil prices, the tight correlation between breakeven inflation and crude oil prices suggests this strategy might work (chart).

As long as bond yields are falling for good reasons (i.e., disinflation) and not bad ones (e.g., a recession), then that's a positive setup for the stock market.

Now let's review today's key market-related developments:

(1) Sentiment. Bears in the AAII sentiment index rose to 42.9% a week ago, the highest since November 2023 (chart). The AAII bull/bear ratio has been relatively depressed since the presidential election. Perhaps a majority of respondents lean left! Regardless, this is a bullish indicator from a contrarian perspective.

(2) Productivity and labor costs. Q4's productivity growth and unit labor costs (ULC) were released today. Productivity growth declined from 2.1% to 1.6% y/y, and ULC increased from 2.2% to 2.7% y/y. Much of the change was due to a big decline in durable manufacturing output amid higher hourly compensation. We expect productivity growth to increase and ULC to fall over the rest of the year for a few reasons.

Falling auto inventories dragged down real GDP growth last quarter, and stalling auto production weighed on output. Nevertheless, tomorrow's big annual revisions to labor force growth will likely raise output and thus lead to an upward revision in productivity growth (thus lowering ULC inflation) (chart). Revisions tend to be large for these series.

Another reason to expect higher productivity growth is the proliferation of AI among a host of diverse businesses. In its conference call on Monday, Palantir executives cited several examples of major companies cutting operational costs dramatically thanks to its AI platform.

(3) Employment. Tomorrow's labor market revisions will show a huge jump in the size of the labor force, and therefore the number of workers employed, unemployed, etc. Historical payroll growth may be revised lower, though we expect the revision to be smaller than the initial benchmark revision of -818,000.

Importantly, ratios like the unemployment rate should be relatively unaffected by the revisions. We expect it to remain low as more recent indicators—like today's releases of Challenger’s data on announced layoffs and initial unemployment claims—show the labor market remains in good shape (chart).

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