By Doug O’Laughlin
Compiler: Deep Tide TechFlow
Sorry for disappearing for a while lately. I just finished moving to New York City while also facing some health issues. One thing I would like to tell you about is that I will be taking a week off from March 27 to recover after outpatient surgery. Now, though, let’s get down to business.
Markets are quickly adjusting their pricing to the impending recession, in part due to the Trump administration’s policies and significant pressure on the dollar. I will give a casual summary from a macroeconomic perspective and discuss the semiconductor industry and my areas of interest. Let’s start with the big picture and then dive in.
An “artificially made” recession with 10-year Treasury yields
Recent commentary suggests that the current administration is placing more emphasis on the 10-year Treasury yield than on the level of the stock market – a departure from past strategies such as the so-called “Trump protection”. The “correction period” was mentioned several times in an interview with Fox News, suggesting that the government’s focus has shifted from stock market performance to bond market signals.
The main measure of this is the 10-year Treasury yield. The 10-year Treasury yield is the interest rate paid by the U.S. government on borrowing, and by lowering this key rate, you can increase the affordability of housing or the ability of consumers to buy cars. However, “manipulating” the 10-year Treasury yield is not as straightforward as adjusting interest rates. Interest rate adjustments are primarily overnight bank lending rates determined by the Federal Reserve, while the price of 10-year Treasuries is a market-driven price determined by auctioning off investors willing to buy government bonds.
Here’s the problem: 10-year Treasury yields aren’t an exact science. No one really knows how the 10-year Treasury fluctuates, the price of which is determined by trading and is thought to reflect inflation and real GDP growth in the countries that issue the bonds.
This poses a challenge. Tariffs could trigger inflationary pressures in the near term, and if the 10-year Treasury yield falls to 3% (as some, such as Bessen predict), this could reflect a downward revision of real growth expectations. In this case, the market may see a recession as a necessary adjustment.
That’s exactly what the market is expecting at the moment. This is a yield curve a month ago and now. Specifically, the short end of the curve begins to decline. This means that the market is rapidly pricing in lower short-term rates and lower federal funds rates. In this case, this may not be a sign of falling inflation, but rather a sign of a weak economy and the market’s belief that the Fed is not cutting rates fast enough.
Source: Bloomberg
We’re experiencing it all in real time. There are technical reasons behind GDPNow, a real-time economic forecasting tool, which is now predicting a significant contraction in the first quarter, but the overall trend is still weakening.
One of the important factors is the impact of net imports on GDP calculations. Net imports are deducted from GDP calculations, partly as an early reaction to tariffs. But beneath this surface, the economy is weakening across the board. The chart above shows the trend of the growth contribution and its estimates. Imports are lagging a lot behind, but more importantly, the rate of change is also worsening in most other categories.
Source: GDPNow
The second chart further shows the weakness in imports, while residential investment, government spending (expected) and consumer spending are also weakening. Similar to the situation during the economic contraction in the second quarter of 2022, the rate of change is deteriorating sharply. Below is a chart of the growth contribution in 2022, when the economy was hit by a significant reduction in inventories.
This situation then quickly reversed with the normalization of inventories. So, will the early tariff effect recover as quickly as the post-pandemic inventory adjustment, or will it lead to a downward spiral in consumer and business confidence?
The problem is that consumer confidence is starting to decline, and some leading indicators, such as consumer confidence and leading economic indices, are also starting to decline. Worryingly, this decline is accelerating. Most economic indicators and consumption data appear to point to further weakness and uncertainty.
The yield curve shows signs of economic weakness at the same time as imports surge, a decline in consumer confidence, and the possibility of a technical recession. The expectation of economic weakness has a reflexive effect, as seeing a weak economy prompts people to save more. Trump now uses the term “transition period,” but that formulation usually doesn’t bode well in the market.
The timing is very delicate. The yield curve has just returned to normal, and that’s almost always the beginning of the pain. When the curve becomes steeper, a pullback or recession begins. In other words, an inverted yield curve usually signals a recession; And when the yield curve normalizes, the recession and the impact on the stock market begins. What we’re seeing now is that the yield curve inverted at the end of September last year.
Source: Koyfin
We are experiencing pain right now. Another key factor is tariffs and uncertainty, because in economics, uncertainty is almost synonymous with volatility. Decision-making becomes more difficult when we can’t determine whether the tariff rate is 10%, 20%, or 25%. One overwhelming theme, however, is trade.
Trade deficit and asset flows
The U.S. has a chronically large trade deficit, which means it imports more than it exports. However, these dollars will not disappear in a vacuum; They are transferred to foreign entities as payments for goods and services. These foreign exchange funds are usually repatriated to the U.S. financial markets through investments. In this way, the trade deficit is accompanied by capital inflows, which finance the purchase of U.S. assets.
This creates a natural impetus to buy US assets with dollars accumulated from the trade deficit. Think of it as a natural inflow of dollars from trade.
Trump’s policy, however, is explicitly focused on trade through tariffs. Tariffs will naturally push up consumer prices, reduce trade, and reduce the trade deficit if tariffs are high enough. This reduces the return of dollars to the United States, which in turn has a more negative impact on asset prices – capital outflows.
Higher tariffs could mean fewer dollars accumulated by foreign entities that are already the largest buyers of U.S. assets. For example, a large Japanese conglomerate with a trade surplus with the U.S. will reduce its purchases of assets, including U.S. Treasuries, due to reduced operations. Considering that the main auction portion of U.S. Treasuries is now facing outflows, and 24% of Treasuries are held by foreign investors, this will reduce the purchase demand of foreign investors, pushing up the 10-year Treasury yield. It’s a very tricky situation.
Rising U.S. tariffs and a negative approach to global trade have led to a natural outflow of assets and prompted some foreign entities to choose to flee U.S. assets. After decades of trade deficits, such a mechanism could be self-fulfilling and seriously spiral out of control. The trade deficit has long existed as a natural source of financial inflows. The following chart of the U.S. share of global market capitalization has been discussed over and over again – and now there seems to be a way to stop the inflow of money: tariffs.
Source: J.P. Morgan Market Guide
Another element of uncertainty is that the “West” is no longer so united. The Financial Times is questioning the transatlantic partnership. It’s one thing to keep assets in an ally’s financial markets, but it’s a completely different story if it’s no longer a strong ally. As the U.S. withdraws and implements reciprocal tariffs similar to the Smoot-Hawley Act (essentially unilateral tariffs that eventually devolved into a bilateral tariff war with Canada), it’s hard to say whether their alliance remains strong.
A split in trade is a split in the Union. And as this continues, there will be an exodus of assets. A retaliatory U.S. government could push European trade toward China, the world’s largest manufacturing base. The world order of the past is at risk, and betting all its chips on the basket of the United States no longer seems to be a wise strategy. So, where do the assets go? Europe seems to be the biggest beneficiary so far.
The reversal of the roles of Europe and the United States
An ironic pattern is that the United States and the European Union are strangely swapping roles. Driven by a raft of AI investment announcements and new plans for potential defense spending, Europe is doing something that has long been overlooked – deficit spending.
At the same time, it can be argued that raising tariffs to increase revenues while sharply cutting costs is exactly what defines austerity. This is exactly the strategy that Europe adopted after the financial crisis, and now the roles are being reversed. The record of austerity is abysmal, while deficit spending has created economic dominance and differentiation in the United States in the wake of the financial crisis.
This may partly explain why asset outflows have begun, with the biggest divergence of assets in developed countries heading to Europe. The huge money that went to the US in the past is now reversing, first going to large liquid assets in Europe or markets in a similar language in the short term. One way to illustrate this trend is the ratio of IEVs (European ETFs) to S&P 500 ETFs. In 2025, the trend of relative outperformance in the United States will be broken, and the trend of capital flows to Europe will become significant.
This will be a long-term trend, as a large number of American exceptionalist deals are unraveling. Another acceleration of this trend is the rapid decline in U.S. asset prices, while the rest of the world has performed relatively well.
But let’s be honest – this is a communication about semiconductors, not macroeconomics. Most of the dynamics mentioned here are basically relatively consistent macroeconomic views and are being quickly priced in by the market. The reality is that significant changes in the market take time and are rapidly approaching the final outcome. This can be a drastic process.
Market dynamics and semiconductors
Finally, let’s go back to my beloved semiconductor industry. I’d like to make some observations. First of all, the situation where the market peaks is very reminiscent of the situation where most markets are falling. There’s an old proverb that says the semiconductor industry leads the market, and from my experience, it’s true.
The chart below illustrates that when the semiconductor sector stops its relatively strong performance, the market tends to see a significant correction in the following months.
But the semiconductor industry is cyclical. We’ve already experienced declines, and if the S&P 500 falls by 10%, then the semiconductor industry is usually down 20%, or even 40% is possible. The market is telling us that the economy is not in good health, which is a forward-looking indicator of changes in orders and future revenue growth for semiconductor companies.
Now the question is, how big will this drop be? We have just seen a 10% drop figure, which is consistent with history. Declines usually take more time and are usually more drastic than that. Considering that the growth scare in 2022 was enough to cause the market to fall by 20%, I think this decline will probably end in this range as well, not to mention that this growth scare is far more severe than in 2022.
Will this lead to a recession? This problem is beyond what I could have predicted. But it’s clear that there are some uncertain economic factors right now, such as trade headwinds and possible financial flows outside the United States. At the very least, we are in the midst of an institutional or environmental shift. This correction period is likely to be just a market correction and economic contraction.
