July 16
Higher federal deficits drive Treasury rates higher.
The reconciliation bill signed by President Trump is estimated to increase primary deficits by $3.2 trillion over 10 years. The dynamic cost, including changes to the economy, is larger at $3.6 trillion. GDP falls by 0.3 percent in 10 years and 4.6 percent in 30 years. See The Penn Wharton Budget Model. See below under Economics.
The Congressional Budget Office is a crown jewel of the federal government. Its staffers do outstanding work. And its economic forecasts are more accurate than the “Blue Chip Consensus. “ In addition its forecasts are significantly more accurate than those of Presidential Administrations.
CBO's forecasts of important economic variables (output growth, the unemployment rate, inflation, interest rates, and wages and salaries) tend to be more accurate than those of the Administration and the Blue Chip consensus,
Tariff workarounds by China.
Tariffs are a clumsy tool. Tariffs are a tax. They are a drag on economic growth.
China transships its exports to the United States through Vietnam and other countries in order to avoid some of Trump’s tariffs.
Malaysia will require permits for exports of high-performance US AI chips, suggesting the government is responding to efforts to keep the processors from being smuggled into China.
From Marginal Revolution , Alex Tabarrock: Tyler and I give an amusing example of how entrepreneurs circumvented U.S. tariffs and quotas on sugar. Sugar could be cheaply imported into Canada and iced tea faced low tariffs when imported from Canada into the U.S., so firms created a high-sugar iced “tea” that was then imported into the US and filtered for its sugar!
Bloomberg reports a similar modern workaround. Delta needs new airplanes but now faces steep tariffs on imported European aircraft. As a result, Delta has been stripping European planes of their engines, importing the engines at low tariff rates, and installing them on older U.S.-made aircraft.
The editorial board of the Wall Street Journal writes: Keep in mind that a tariff is a tax, and when you tax something you get less of it. One weakness of tariffs as a revenue vehicle is that they restrain trade in goods and thus can raise less revenue than anticipated on a static basis. That’s even more likely if a trade war dampens overall economic growth.
To reduce the deficit taxes must go up on EVERYONE and entitlements must be reformed.
WHY WON’T WE recognize the truth? What is the typical person’s thought process ?
Markets and Stocks
The June CPI numbers were benign. Core CPI came in at 0.2%, one tick better than expected. This is positive for equities.
The economy continues to expand. The AI trade is re accelerating. The manufacturing sector is okay. Momentum is positive. But stocks are not cheap. Invest don’t trade or speculate.
Nvidia, TSMC, ASML, Dell and Micron, among others in the AI stack, remain great investments.
dailychartbook (@Daily Chartbook) posted: "Goldman Sachs sees hyperscaler capex increasing sharply through 2027 – capex is projected to be $1.15T from 2025 through 2027, more than double the $477B spent from 2022 through 2024."
JP Morgan reported strong numbers. JPM is a great long term investment. But the stock is a little expensive at current levels. I believe it is a buy on weakness.
Fastenal sells into many industrial end markets. Its earnings provide a good read on the state of the economy. FAST reported strong earnings.
https://www.barrons.com/articles/industrial-stock-fastenal-earnings-pmi-bcf7be86
We are at the beginning of the AI trade. Meta is building gigawatt and larger size data centers. A gigawatt of power can electrify almost 750,000 homes.
While most data centers today house only hundreds of megawatts of capacity apiece, several AI and major technology companies like OpenAI and Oracle Corp. are involved in plans to develop facilities capable of handling several gigawatts. https://www.bloomberg.com/news/articles/2025-07-14/zuckerberg-says-meta-to-build-several-gigawatt-size-data-centers
Meta’s competitors, Alphabet Amazon and Microsoft will be forced to compete and continue to invest aggressively in data centers.
Energy demand in the U.S. will double over the next decade because of the AI revolution. See CNBC.
Natural gas and nuclear power will provide the electricity for AI data centers. The natural gas company EQT is an excellent investment. The uranium sector is attractive long term but it is higher risk. Rolls Royce with its small modular nuclear power technology is a great investment.
Nvidia will receive export licenses for its H20, less powerful, chip to be sold to China.
Aerospace and defense stocks are great investments. This theme should last for a decade and probably longer.
The iShares U.S Aerospace & Defense ETF, symbol ITA, is up 33% this year. GE Aerospace, RTX and Boeing are all excellent investments.
Rolls Royce continues to be a table pounder. Rolls Royce is a triple play on commercial aerospace, defense and small modular nuclear reactors.
The company sold its car business several years ago. The stock is up 1200% since I first wrote about in 2022. I believe it will double by early 2027.
China
Chinese home prices continue to decline. The Chinese economy will be stuck in a deflation cycle until its housing prices begin to appreciate.
China’s home prices fell at a faster pace in June, underscoring growing speculation for additional measures to revive the property market.
New-home prices in 70 cities, excluding state-subsidized housing, dropped 0.27% from May, the most in eight months, National Bureau of Statistics figures showed Tuesday. Values of second-hand homes fell 0.61%, the biggest decline since September.
Economics
Increases in the federal deficit pushes interest rates higher. Higher deficits raise risk.
This paper revisits the relationship between federal debt and interest rates, which is a key input for assessments of fiscal sustainability.
Estimating this relationship is challenging due to confounding effects from business cycle dynamics and changes in monetary policy.
A common approach is to regress long-term forward interest rates on long-term projections of federal debt.
We show that issues regarding nonstationarity have become far more pronounced over the last 20 years, significantly biasing the recent estimates based on this methodology.
Estimating the model in first differences addresses these concerns.
We find that a 1 percentage point increase in the debt-to-GDP ratio raises the 5-year-ahead, 5-year Treasury rate by about 3 basis points, which is statistically and economically significant and highly robust.
Roughly three-quarters of the increase in interest rates reflects term premium rather than expected short-term real rates.
https://www.nber.org/papers/w34018
Tariffs are negative for economic growth.
President Donald J. Trump's new tariffs could generate trillions of dollars in new federal government revenue over a decade, but the net gain would be reduced by the measures' damage to the US economy and other countries' likely retaliation.
We find these higher tariff rates generally produce more tariff revenue. But they also reduce other tax revenue from companies and households by hurting economic growth—resulting in lower GDP, investment, employment, and real wages than otherwise. The effects are amplified if other countries retaliate by imposing the same tariffs on imported US goods.
Indeed, with retaliation, a 20 percentage point rate increase yields a smaller gain in tariff revenue than the 15 percentage point increase because imports drop more, as does revenue from the other two sources. This produces a net revenue gain from all three sources of $791 billion over a decade, the smallest amount in the scenarios examined here.