WEEK AHEAD

Tariffs, Tensions, and Tepid Inflation: A Volatile Week in Review

Early last week, the market surged following U.S. and Chinese negotiations that agreed on a framework covering a bunch of policies, including that U.S. tariffs will be set at 55% and China's at 10%. Additionally, China will approve the exports of rare earth minerals. At the same time, the U.S. will roll back restrictions on the export of advanced technology. However, sentiments fell on Friday as the Israel-Iran conflict intensified, specifically Israel's sudden, pre-emptive military action against Iran in a critical energy-producing region, which resulted in the S&P 500 ending the week with -0.46% movement.

The past week also saw the release of U.S. consumer prices, which rose at a slower pace than expected in May. CPI came in at 0.1% MoM and 2.4% YoY, while Core CPI was reported to be 0.1% MoM and 2.8% YoY, all of which were below the forecasted figures. On the other side, U.S. producer prices returned to growth in May but rose by less than expected. MoM PPI and Core PPI both came in at 0.1%, compared with the negative growth in the previous month and the forecasts of 0.2% and 0.3%, respectively. Soft CPI and PPI data suggest muted inflation. However, concerns linger over President Trump's tariff policies, which could push inflation higher. Though some tariffs were delayed, others remain, raising the effective tariff rate. Treasury yields have been on the decline over the past week, helped by the subdued inflation report. Markets anticipation of a potential rate cut in September or later has improved. Analysts suggest that businesses may be absorbing tariff costs to avoid passing them on to consumers but warn that persistently high tariffs could drive inflation higher in the future and delay Fed action until December.

Economically, due to a de-escalation in U.S.-China trade tensions, consumer sentiment has recovered after a prolonged period of depression, and expectations for future inflation have eased. Nevertheless, the labor market remains sluggish.

Here's a breakdown of key economic reports from the past week:

• NFIB Small Business Optimism increased three points to 98.8 in May, rising for the first time since December.
• Michigan Consumer Sentiment improved for the first time in six months in June, which soared to 60.5, far exceeding the forecasted 53.5.
• Michigan's 1-Year Inflation Expectations in June were reported at 5.1%, below the forecasted 6.4% and the previous month's 6.6%
• Wholesale Inventories showed modest growth of 0.2% for April, which beat the forecast, amid stockpiling of prescription medication in anticipation of potential tariffs on imports of pharmaceutical products.
• Initial Jobless Claims were reported at 248K this week, with Continuing Jobless Claims at 1956K, both of which exceeded forecasts, potentially suggesting the U.S. labor market is losing some momentum

Week Ahead

Investors are on edge over risks ranging from heightened prospects of a broad Middle East war to U.S.-wide protests against the Trump administration. Market participants are closely watching these developments, aware that any escalation could significantly impact global risk sentiment and asset prices.

At the same time, a series of key economic indicators due this week – such as Retail Sales, Industrial Production, and the Philadelphia Fed Manufacturing Index – are expected to provide crucial insights. However, the centerpiece of the week will be the Fed's interest rate decision on Wednesday. With the latest CPI and PPI data coming in softer than expected, the market is actively debating how the Fed will interpret and react to these signals. Investors will be paying close attention to the Fed's statement and Chair Powell's press conference for clues on the future direction of policy.

The US Government Debt and Deficit Are Symptoms of a Much Bigger Problem

Moody's Downgraded the US… Should You Care?

The S&P downgraded the US credit rating in 2011. Then, in 2023, Fitch followed suit. Finally, Moody's pulled the trigger on May 16, 2025. Their decision followed a review of the latest White House proposal—code name "One Big Beautiful Bill"—adding $3.3T in new debt over the next 10 years.

For context, the stock market dropped 7% after the S&P downgrade. The Fitch downgrade led to a more muted decline of 2.3%. This time, the stock market didn't flinch—but the bond market showed irritation, with the 30-year yield rising above 5%.

But should you be concerned?

The 2025 budget, passed in April, already entails a $1.9T deficit this year. Total debt stands at $36.7T. What's another $0.33T per year, incrementally?

Whether you like or dislike the Trump administration, this has little to do with Trump. If President Trump doesn't spend more, we believe the next POTUS will.

Who would stop the music and spoil the party? And to what end? Who are we really hurting with all this debt—a debt we neither plan nor need to repay?

The US Technically Can't Default. How Does the Massive Debt Matter Then?

The US would not actually default on its debt! US debts are issued in USD. The US is uniquely skilled at manufacturing the USD—that is our biggest comparative advantage, after all! We can always print more USD to pay.

We don't believe the credit downgrading is about "US default risk." It warns of the decline in the value of the dollar—driven by ever-larger government bureaucracy and worsening efficiency. We believe the math of currency debasement is straightforward.

When the state bureaucracy doles out financial wealth through pork and welfare—often creating more wealth for the administrative machine than the recipients of the welfare—we find no corresponding real production occurs. As the government grants wealth, it essentially gives consumption rights without earned contributions. This usurps the wealth that other American workers have earned.

On the other hand, if the government spends wisely on critical infrastructure, education, or research, the resulting productivity gain is deflationary. For that reason, good government policy often drives strong USD.

In downgrading the US, the rating agencies signal their judgment: federal spending is increasingly wasteful, and the expanding role of government risks crowding out the private sector. A higher inflation and a weakening USD are, therefore, the future.

Back to First Principles: What Is "Money Printing"?

Before we get too far, let's be absolutely clear: when economists talk about "printing money," they don't mean the actual production of dollar bills by the Bureau of Engraving and Printing to replace worn-out bills.

In reality, when we say the Fed "can print money," we mean it can borrow, at will, an unlimited amount of money from the big banks, which hold the collective savings of Americans. The Fed also gets to "choose" the rate it borrows at and when it repays the debts.

The Fed: Enabler of the Government's Spending Addiction

With potentially infinite access to money, the Fed is the lender of last resort—not just to troubled banks during financial crises but to the US government when other lenders are reluctant. When push comes to shove, the Fed can and has always "bailed out" the spending addiction of our political rulers.

Thus, the US government cannot technically default on its debt servicing. When facing maturing debts, it simply issues new bonds, which the Fed stands ready to buy with its unlimited credit card! The government's debts and interests are easily rolled over.

Once you understand the mechanism, you shouldn't be surprised that the government has $36.7 trillion in debt, approaching $ 40 trillion. With unlimited credit and infinite refi—you, too, will owe $36.7T.

An Independent Fed? A Good Theory at Best

Technically, the Fed is independent. However, its chairman and board of governors are appointed by the President of the United States. While the POTUS can't fire a Fed Chair, he certainly has leverage.

Frankly, no one is appointed the Fed Chair without a track record of having "played ball" well. Counting on the Fed to be the adult in the room—that it will discipline politicians by withholding funding for pork and welfare—is idealistic.

Argentina has had a long list of short-lived Central Bankers. It most certainly is not because they repeatedly pick bad economists who can't manage inflation. He, who refused to print to fund the President, didn't survive long on the job.

Let's be honest: our two political parties are in collusion to never balance the budget. Sadly, neither the debt ceiling nor the Fed independence has credibility in stopping our political rulers from spending more.

How Much Debt Is Too Much?

The government's unlimited credit card is backed by the collective balance sheet of all Americans. The tipping point comes when liabilities exceed assets.

The press often cites the US debt-to-GDP, now 130% ($36.7T/$28T). But comparing debt to income misses the broader picture. A better metric is debt-to-wealth.

US national wealth is estimated to be $ 170 trillion. With an annual income of $28T and tax receipts of $5T, the government spends $7T—resulting in a $2T deficit. Households save approximately $1 trillion per year.

Terrifyingly, the government spends $1T more than we collectively save. Fortunately, rising asset values (in stocks and real estate) have offset this imbalance.

The US debt-to-wealth ratio is about 20%. For comparison:

• Japan: $8.6T debt / $27T wealth = 32%
• UK: $3.9T / $16.4T = 24%
• Greece: $0.4T / $1.1T = 36%
• Argentina: $0.46T / $1.2T = 38% (improved from 45% before Milei)

Has the Debt Grown Out of Control?

Thirty years ago, the US government debt was $ 3.6 trillion. Today, it's $36.7T. However, national wealth also rose tenfold, from $17 trillion to $ 170 trillion. Debt-to-wealth ratio is unchanged at ~20%.

We think some body fat is fine—necessary. But we shouldn't be obese. At 20% "body fat," we're tolerable. But we should be ever vigilant regarding the trajectory.

For now, there is, perhaps, an organic awareness—a built-in restraint that keeps the government from driving the economy into ruin.

A sensible parasite doesn't kill its host.

Debt and Deficits Are Signals, Not Causes

Let me prove to you that the government deficit is not the primary concern.

Let's tax an additional $2 trillion to eliminate the US budget deficit. However, we fund the same government expenditure—including all the same waste, welfare, and pork. Have we solved the real problem? Economic theory would predict similar inflation and growth drag.

The question isn't how we fund inefficiency—it's whether the inefficiency itself is acceptable.

The government invests in schools, infrastructure, basic scientific research, and law and order—things that private for-profit companies don't naturally undertake. However, most people suspect that a substantial amount of the budgeted spending is wasteful: bloated welfare state and pork.

Looking naively at our deficit would misguide us on the bigger problem: the government—this inefficient non-profit entity has grown from an iguana to a Komodo dragon. If we aren't careful, it could become Godzilla.

Japan, the UK, and the US run government deficits of 3.5%, 5%, and 6% of GDP, respectively. The US ranks poorly here. Deficits mislead you here. Let's look at actual government imposition:

• Japan's government spends $1.7T of its $4.2T GDP → 41% (stable over 20 years)
• UK: $1.7T of $3.8T → 44% (worsened rapidly in the last five years from ~30%)
• US: $7T of $28T → 25% (deteriorated over the previous five years from ~20%)

In terms of government footprint, the US still looks reasonable for now!

At its worst, Greek government spending hit 70% of GDP. Argentina peaked at 140% and averaged 80% until Milei brought it below 40%.

Do not let deficits and debt—which are financing problems—distract you from the real problem. In our opinion, good firms don't fail because they choose to finance their bad projects with external debt instead of internal equity capital. Good firms fail because they keep funding failing divisions.  

Ironically, a large deficit—a visible warning sign that forces public awareness—might help. It reminds politicians that the public won't pay more taxes to fund bloated programs.

Government: A Necessary Evil?

What can we do? Perhaps not much—except hope.

A well-behaved parasite coexists with its host. Argentina has shown what happens when that balance is broken. The host dies. So does the parasite.

For now, for the US, there is no threat of bankruptcy to deter government spending. We predict that Moody's, or the "bond vigilante," will, in due course, be overruled by the Fed, which ultimately serves the US government. To be sure, pork and welfare will keep flowing. The parasite is still mindful not to kill the host.

Back to the original question: Who are we really hurting? Wise men have said in different tongues and different words: Life is not fair. Get over it. If you are a red blood cell or T-cell, be glad that the body will live and even thrive despite it all.

Disclosure: This article contains opinions which are subject to change without notice. The reader should not construe these opinions as a recommendation to invest in any security or as investment or financial advice.