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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management Bi-Weekly Asset Allocation Report for 03/31/2025. I'm Phil Adler. It appears a slowdown now underway may be part of the Trump administration's economic plan. Confluence Associate Market Strategist, Thomas Wash, joins us today to discuss why investors should pay close attention to how well any slowdown is managed. Thomas, the administration's tariffs are designed, as many understand it, to encourage domestic production.
Phil Adler:And inflation, it appears, may be regarded as an initial unwelcome but necessary side effect. Do you agree that the administration seems to view an initial slowdown as necessary to meet its long term economic goals?
Thomas Wash:Basically, the administration's goal is to address what it sees as a structural imbalance in The US current accounts. Officials within the Trump administration believe that some countries have exploited the global trading system to boost their exports to The US, A dynamic they argue has come at the cost of American jobs. They view tariffs as a useful tool to rebalance trade flows and potentially undo some of the perceived harm caused by existing trade agreements. Now that said, tariffs remain controversial. They risk disrupting supply chains and in some cases may cause businesses to delay investment until there's greater clarity on trade policy.
Thomas Wash:However, if the administration believes short term economic pain is necessary to steer the economy toward long term stability, that could explain its willingness to tolerate recent volatility in equity markets.
Phil Adler:Well, policy changes seem to be happening very quickly. Quickly. What is behind the apparent strategy to front load these changes and suffer what the administration hopes will be temporary short term pain to the beginning of a four year term?
Thomas Wash:I I believe the the strategy of front loading painful policies may stem from lessons learned during Trump's first term. At that time, the administration prioritized tax cuts to bolster the economy, believing this would position The US for a trade war with China. This proved to be a miscalculation as the administration failed to secure its key trade policy objectives, including negotiations on USMCA as well as China before the twenty twenty election. Now the approach appears to be different. By accelerating tough measures early, the administration aims to create enough runway to fully implement its agenda.
Thomas Wash:For me, the logic is clear. Tackling the hardest challenges now while the president retains relatively strong public support maximizes the chances of achieving lasting results.
Phil Adler:Thomas, in your report, you look at the Reagan recession in the early eighties for clues on current Trump strategy. What are the lessons of that period?
Thomas Wash:While trade dominates today's economic headlines, inflation was a defining challenge of Reagan's first term. His administration took the politically step of granting the Federal Reserve autonomy to aggressively tighten monetary policy even at the cost of inducing a sharp recession. This painful but decisive action ultimately tamed inflation, setting the stage for Reagan's nineteen eighty four landslide reelection. Now when you say the lesson, the lesson learned is that if economic contraction is necessary, it's better to front load the pain and ensure recovery comes well before voters head to the polls.
Phil Adler:What do you think is key to the Trump administration's current efforts to manage any economic slowdown?
Thomas Wash:Well, the critical factor in managing an economic slowdown is preventing a full blown financial crisis. History shows that when bank panics occur, recessions tend to become deeper and longer lasting. These severe downturns are particularly damaging for presidential administration as they often lead to a fundamental loss of public confidence in economic leadership and have long lasting impact on the president's legacy.
Phil Adler:Is the administration banking on rate cuts by the Fed to ease the pain of inflation?
Thomas Wash:Sure. Like, the administration appears to view the Federal Reserve as providing a potential economic safety net, if you will. Although the Fed has already cut rates by a hundred basis points over the last year, current rates remain elevated compared to historical norms over the previous fifteen years. Moreover, the Fed's balance sheet expansion could serve as an additional policy lever should further rate cuts fail to sufficiently stimulate economic activity.
Phil Adler:Won't further rate cuts actually encourage inflation?
Thomas Wash:Do rate cuts always push up inflation? Not necessarily. It really depends on the economic environment. Take the aftermath of the great financial crisis. Even with near zero rates, inflation stayed stubbornly low.
Thomas Wash:Why? Because while cheap borrowing let households refinance mortgages, the bigger picture was bleak. Businesses were still shaky, hiring was slow and confidence was relatively low. Without strong job growth or rising wages, prices had little reason to spike. So rate cuts can add to inflation, but only if they actually boost confidence and get people spending again.
Phil Adler:What are the dangers of an extended economic downturn, do you think, right now? And how might the administration deal with those dangers?
Thomas Wash:Should the Federal Reserve prove unable to stimulate economic recovery, fiscal intervention may become necessary. Recently, conservative lawmakers and Elon Musk's Doge task force has advocated for government spending cuts. If implemented today, such austerity measures could create fiscal capacity for targeted stimulus programs to reignite growth in an event of a recession. However, this approach could lead to another surge in the government deficit, which could lead to higher interest rates, inflation, and in a worst case scenario, could potentially precipitate stagflation.
Phil Adler:Thomas, it seems to me that investor and voter confidence is essential for the administration to achieve its economic goals. It's, no doubt too early to accurately grade the administration's management of a slowdown, but I'd I'd like to try anyway. How would you describe the market's reaction so far?
Thomas Wash:I think the market's reaction appears largely justified. Like, at the start of the year, there was considerable skepticism about whether the Trump administration would fully implement its trade agenda, with many investors dismissing it as merely a negotiation tactic. Furthermore, the administration's aggressive trade posture toward traditional US allies caught many within the market by surprise. However, at this stage, I believe most downside risks are nearing full pricing. Now barring a major escalation, we may see the peak of trade war tensions within the next three to four months.
Phil Adler:What do current readings on consumer confidence and spending tell us?
Thomas Wash:You know, that's a really interesting question. People are definitely feeling uneasy about the economy right now, and businesses are starting to tighten their belts too. Airlines are seeing fewer bookings and FedEx is delivering less, which is usually a red flag. But here's the thing, the government official data, it's still painting a pretty good picture of the economy. So you've got this big disconnect between what people are feeling and what the numbers are showing.
Thomas Wash:So it's hard to know what to believe at this point.
Phil Adler:At this point, do you think would a market pullback cause the Trump administration to pull back from tariffs?
Thomas Wash:So that's the whole Trump put thing where the government was supposed to step in if the market fell 10%. Turns out they're not really doing that, and they're just letting it go even with all the trade worries. They seem pretty chill about the market swings for now, but I think a full on bear market, let's say a 20% drop? That may change everything. I'm guessing they're kind of crossing their fingers and hoping that the tax bill that they pass will give everyone a boost in confidence, and we could see a new record in the S and P 500 by December.
Phil Adler:Well, tariffs are are certainly not the only policy in the spotlight. There's government cutbacks, foreign policy decisions to pull back from long term alliances, and those may not please many voters. Is there a danger that resistance to those plans may decrease confidence in the administration's ability to manage an economic slowdown?
Thomas Wash:You know, the administration's push to shrink government and cut social spending, that's definitely creating a lot of uncertainty. I think that's where the consumer confidence drop is actually coming from. You know, people are worried about these big moves, especially with the trade war stuff, are gonna mess things up even more. But here's the thing, I'm not convinced they'll get all the cuts they want. Courts are already starting to push back against some of the government layoffs and congress is starting to fight back on certain social spending cuts.
Thomas Wash:Even so, I do think that just the loss of government jobs is making people feel nervous.
Phil Adler:What should investors finally, Thomas, take away from these early efforts by the Trump administration to acknowledge the possibility of a slowdown and manage it.
Thomas Wash:Alright. Here's the thought. If the Trump administration actually manages to fix the trade stuff and get us less reliant on foreign companies, US businesses can end up having a field day because they'd have less competition, therefore giving them much more pricing power. But in order for that to happen, there's gonna be some type of bumpy transition. So you'll probably see people piling into gold since it's always a safe bet when things are shaky.
Thomas Wash:And if you're into bonds, extending duration might be a good play, especially if those yields keep falling.
Phil Adler:Thank you, Thomas. This week's report is titled managing an economic slowdown. You can find a link to the written report on confluenceinvestment.com. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice, and this information does not constitute a solicitation or an offer to buy or sell any security.
Phil Adler:Our audio engineer is Dane Stole. I'm Phil Adler.