Dusting Off the History Books

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De-constructing the Dollar

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Soundbite: The data is in, and there does not appear to have been international liquidations of U.S. assets during H1 2025. Foreign asset managers kept U.S. assets but neutralized their Dollar risk; hence, the real force driving the Dollar down was from hedging currency exposure. Going forward, the direction of the Dollar could be determined by future hedging flows on the enormous inventory of U.S. assets held abroad. The only way we could see a Dollar free-fall is if there is repatriation involving wholesale liquidation of U.S. holdings caused by increasing evidence of commercial bank loan write-offs.

George Saravelos from Deutsche Bank made an incisive comment that when the source of instability is outside the U.S., such as the Ukrainian invasion, U.S. stocks fall but the dollar rallies. When the cause of volatility is within U.S. borders, such as Silicon Valley Bank, the dot.com bubble, or our tariff policy, then both assets weaken in tandem.

That observation is worrisome because if more negative write-offs are announced due to U.S. bank lending to nondepository financial institutions, foreign investors could become so pessimistic that they sell their underlying U.S. assets. If we face more damaging news regarding domestic lending to Private Capital firms, that could cause stocks and the dollar to drop quickly. A weak currency would spark a negative feedback loop, creating even more equity selling.

We cannot forget the massive amount of total dollar investments that accumulated over the years, which dwarf any current flow of funds buying dollar assets. This fact makes hedging activity the key factor moving ahead. Year-to-date, the S&P 500 is underperforming the EAFE, EM, and Eurozone indices, but over the last 15 years, the U.S. is still a massive outperformer. That inertia has kept foreign investors from liquidating. Although U.S. assets remain coveted, continued currency hedging could push the dollar lower as those hedges roll over every three to six months.

What could cause a Dollar rally?

The easiest path would be if economic activity begins to pick up as firms start to spend in anticipation of the immediate expensing of R&D expenses and a deregulatory environment. That would cause the Fed to focus less on cutting rates preemptively to stave off job losses, raising the cost of currency hedges and lifting the major overhang on the Dollar. Unless something happens to shift the demand curve for Dollars, however, we could continue our 96-100 range in the Dollar Index that has contained the greenback’s range since April. A break below 96 will not be welcome news for the stock market.

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Guv’nah

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Soundbite: Analogs to our current market situation run deeper than the data center buildout to the internet bubble, and recent bank lending losses to the global financial crisis. Bank of England Governor Andrew Bailey looked back over centuries of economic theory and concluded that, as always, extending credit to innovative technologies increases productivity, resulting in rapid growth. We believe this view is behind today’s optimism around the AI theme. However, we fear that Bailey is talking about a long-horizon process that demands investors extend their trading horizon beyond what is currently in fashion. Any near-term turbulence will quickly test the resolve of today’s myopic speculative fever. The BoE's head agrees with us that we face a tariff-induced supply contraction, as well as a reduction in labor supply due to immigration policy. If that unfolds, central banks have a tough road ahead, struggling with stagflationary forces. That struggle could sour sentiment and cause position reductions before Bailey’s long-term view manifests.

Tighter monetary policy cannot reduce inflation caused by supply side shocks, such as tariffs. Monetary policy is suited to fight shocks in aggregate demand, which works well assuming stable supply side dynamics exist. Unfortunately, supply side problems have become a minefield, thinking back to what unfolded during the pandemic, or Russia’s invasion of Ukraine, and now, tariffs. Governor Bailey relied on his prior role as an economic historian to give investors proper perspective.

There are two important points we took from his speech on the nature of supply-driven growth:

· It is important for impatient bulls to understand that delays and disappointments for AI will be the rule, not the exception, over time. Supply side growth comes in waves and accelerates with “General Purpose Technology innovations, starting with the steam engine, moving through electricity, and eventually on to the internet.”

· Leaders do not pull laggards upward; the current top-heavy condition of stock leadership is not unusual throughout history. Therefore, do not anticipate a broadening of leadership into other sectors. The delays are normal because supply side growth historically is not evenly distributed. Today’s economic duality of slow overall manufacturing productivity co-existing with concentrated explosive growth in tech stocks dates back to the Industrial Revolution.

Governor Baily referenced Malthus’ warning that population growth would outrun the world’s capacity to feed itself. That led to his famously incorrect dismal growth outlook two centuries ago. Aging demographics and U.S. immigration policy combine to create the opposite situation that faced Malthus, where labor supply is contracting, not expanding. Ironically, we could arrive at his conclusion of downward growth momentum, but this time, contracting labor growth sets up an economic headwind.

Increased agricultural productivity righted the ship in the 1800s, and Bailey expects the AI-productivity boost will be our silver lining. While all points today lead to restrained growth based on de-globalization—the degree to which an economy is open determines how fast it can grow—the Governor believes that “over a longer time, trade will adjust and rebuild.” Our only caveat is that “over time” we can expect periods of elevated volatility, making the preferred investing approach more active than a Nifty Fifty buy-‘em-and-forget-‘em strategy.

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Gold Bulls, Meet Mr. Kindleberger

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Soundbite: Seeing gold forecasts of $8000 and higher gets our antennae up that extreme sentiment may be creating a multi-month peak in precious metals. Price-insensitive global central banks may push the commodity higher, but the monthly percentage gains in gold are so extended that they resemble past periods of buying exhaustion. That does not spell bear market, but it does get us thinking about how one could develop. Just as it has in the past, tariffs should lead to margin squeezes, and the resulting higher unemployment triggers a reduction in liquidity from lower sales and diminished investment. Secondly, when trade is “rebalanced,” the current account deficit shrinks, simultaneously lowering the capital account, meaning we experience reduced foreign capital flows that also take liquidity out of the system.

If history repeats itself, there is a significant illiquidity issue on the horizon that represents a major deflationary force. Less liquidity is deflationary, and that is why gold fell during the Global Financial Crisis, despite gold investors buying based on currency debasement and flight-to-safety views.

Perhaps this is the wrong week to talk about bad news coming from tariffs, given the enthusiasm greeting the news about a potential Xi-Trump trade deal. However, tariffs are going to be a permanent feature moving forward, and there will be two different forces withdrawing liquidity from the system that can generate deflation that will depress gold prices. This is not our base case, but this is an economic perspective that every gold bull should be aware of. Fifty years ago, the economist Charles Kindleberger laid out the deflationary forces at play when tariff policy goes bad.

Our economic circumstances track the initial stage of Kindleberger’s framework perfectly: market participants do not see any smoke. Tariffs are being absorbed, and the economy has successfully sidestepped any damage. This is the first round in his multi-stage process. As happened a century ago, firms are unable to push price increases through for fear of losing market share. As we pointed out last week, U.S. importers front-loading inventories before the tariffs hit delayed the next phase. Delayed does not mean canceled: the next phase, where lower margins cause firms to lay off workers and begin the deflationary process, is very much a possibility.

If the Fed does not cut fast enough to add liquidity, Kindleberger warns a liquidity shock will begin because companies forced by rising costs will cut production, start firing, and stop investing. This puts downward pressure on consumption, and things spiral lower.

A second liquidity drain comes from the way trade works through the economy. The current account deficit will narrow thanks to tariffs, but that means the capital account surplus (measuring the capital inflow created by the trade deficit) will shrink. The capital account is the huge asset stockpile that is being hedged to eliminate currency exposure that we discussed in the first Point above. Shrink the trade deficit, and the amount of capital available from exporters to invest back in the U.S. shrinks. The outcome is another source of reduced liquidity.

We cannot blame the market for not being concerned because the Fed also has not pushed this agenda. We would be surprised if the members of the Federal Open Market Committee were not acquainted with the Kindleberger spiral outlined above. Even so, political realities make it almost impossible to discuss tariffs, leading the nation into a liquidity seizure. Without any data to back it up, even if the Kindleberger playbook is unfolding in textbook fashion, potential negatives are simply not part of investor mentality.

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What to Look for This Week

(All times E.S.T.)

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1. Wednesday, October 29, at 2:00 p.m. the FOMC statement and rate cut decision will be announced. With futures pointing to a lock for a 25-basis point cut, it is not a consideration that the FOMC to keep rates unchanged. We will look for any suggestions for keeping rates steady at the upcoming December 9-10 FOMC meeting during Chair Powell’s 2:30 p.m. Press Conference. Bank of Canada rate announcement earlier that day at 9;45 a.m. and press conference at 10:30 a.m. that we will focus on given the latest halt in trade talks and 10% bump in tariffs. BOJ rate decision at 11:00 p.m. Thursday, October 30 at 9:15 a.m. ECB rate decision.

2. Wednesday, October 29, after 4:00 p.m. market close, Microsoft, Google, and Meta announce earnings. Capital spending will be an investor focus. Thursday, October 30, Apple and Amazon report Q3 earnings after 4:00 p.m. market close.

3. Friday, October 31 at 4:15 p.m. the Federal Reserve releases its H.8 report on Assets and Liabilities of Commercial Banks in the U.S for the week ending October 22. Loans to nondepository financial institutions. Just hit a new high for last week, although there was no spike higher. For now, there is no new cluster of bad loans needing to be reclassified as financial entity borrowings.

FOMC Voters Speaking: Following Chair Powell’s press conference on Wednesday, October 29 at 2:30 p.m. Fed Governor Michele Bowman is slated to speak about at 9:55 a.m. She might not discuss policy but instead center on regulatory issues. Thursday, October 30, 2026, FOMC voter and Dallas Fed President Lorie Logan speaks on Thursday, October 30 at 1:15 p.m. and at 10:00 a.m. Friday, October 31. Cleveland Fed President and 2026 FOMC voter Beth Hammack speaks at noon on Friday October 31.

Earnings: In addition to the five mega cap tech companies reporting listed above, Tuesday, October 28 before market open Hong Kong Shanghai Bank (HSBC) and Royal Caribbean (RCL) for any news on loan losses and consumer strength, respectively. After market Visa (V) with more consumer spending insight. Wednesday, October 29 before market open Caterpillar (CAT) we look for follow-up on what the company has already revealed about prohibitive tariff impacts. Thursday, October 30 Mastercard (MA) reports before market open.

By Peter Corey

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