2024/11/13 Market Commentary: U.S. Fiscal Policy, Musk to Lead DOGE

By US Tiger Research

$Tesla Motors(TSLA)$ U.S. stocks, $Gold - main 2412(GCmain)$ , and $Bitcoin(BTC.USD.CC)$ all surged before pulling back, while the U.S. Treasury yield curve continues to normalize.

On Wednesday, the Bureau of Labor Statistics released the October CPI data, and as shown below, both headline and core CPI met expectations. The impact of a high base effect has mostly faded, meaning the toughest part of fighting inflation may be here.

However, we remain optimistic that the downward trend in inflation will continue in the short term. More sensitive indicators like the New Tenant Rent Index (NTRI, which leads CPI by about two quarters) and All Tenant Regressed Rent Index (ATRRI, which leads CPI by about a quarter) have both continued to show a slowdown in Q3, as illustrated in the third chart below.

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Source： Factset

A graph showing a line of a mountain Description automatically generated with medium confidence,Source： Factset

Source： BLS，US Tiger Research

After the CPI release, as shown below, the market’s probability forecast for a 25-bps rate cut by the Fed in December jumped from 58.7% yesterday to 82.5%.

Source： CME FedWatch

Wednesday’s most intriguing news, however, was Trump’s appointment of Elon Musk and Vivek Ramaswamy to lead the newly established Department of Government Efficiency (DOGE). Trump’s intention for Musk to head DOGE isn’t newsworthy in itself; what stands out is that Trump, in his statement, referred to Musk as “the Great Elon Musk” (see below). While Trump is known for hyperbole, using “the Great” in an official context is unprecedented in my memory, underscoring Musk’s stature in Trump’s eyes.

A document with text on it Description automatically generated, Source： x.com

Throughout his campaign, Trump frequently expressed concerns about U.S. inflation and the deficit, pledging to implement plans to tackle both, including the establishment of DOGE. But the market doesn’t seem convinced. Following Trump’s election, both the dollar and U.S. Treasury yields have risen significantly. The rationale seems to be

1. Trump favors further tax cuts, and the market doubts he will truly curb government spending, which could further drive up the U.S. deficit and increase Treasury issuance.

2. Additionally, Trump’s deregulation stance is seen as beneficial for the U.S. economy, making it harder to reduce inflation or even sparking reflation.

3. Higher tariffs and immigration restrictions (given the past few years’ influx of low-cost labor) could also drive inflation up.

4. Higher deficits + increased Treasury issuance + rising inflation = higher rates.

5. Higher Treasury yields, in turn, further strengthen the dollar.

Essentially, the market doesn’t believe DOGE will effectively curb government spending. However, with Musk at its helm and Trump’s backing, I think the market might be underestimating DOGE’s potential. After all, this is someone who slashed Twitter’s workforce by 75% while keeping it operational. Musk has publicly claimed that under his leadership, DOGE could cut U.S. government spending by $2 trillion, though it’s unclear whether he means over Trump’s four-year term or annually.

In fiscal year 2024 (ending September 30), U.S. government expenditures totaled $6.75 trillion, with revenues at $4.92 trillion, resulting in a $1.83 trillion deficit. Assuming a conservative scenario where Musk manages to cut a total of $2 trillion over four years, that would average out to $500 billion per year, or 7.4% of FY24’s total expenditures and 27% of the deficit.

A graph of a fall Description automatically generated with medium confidence,Source： fiscaldata.treasury.gov

I fully support reducing government spending and the deficit, though I do worry that Trump and Musk might go too far. It’s worth noting that of the $6.75 trillion in government spending, most contributes directly to GDP, aside from interest expenses (which exceed $1 trillion). Given the fiscal multiplier effect, government spending likely contributes more to GDP than the expenditure itself. With a 2023 GDP of $27.36 trillion, cutting $500 billion in non-interest spending could impact GDP by at least 1.8%. Tax cuts and deregulation likely won’t fully offset that 1.8% impact. However, I see a potential win-win solution:

1. Include some interest expense reductions within the $500 billion cut, minimizing GDP impact while helping offset tariff and immigration-related inflation.

2. Use tax cuts and deregulation to counterbalance the reduction in fiscal spending.

3. Economic slowdown would cool the labor market, reduce inflation pressures, and push the Fed to accelerate rate cuts, potentially ending QT or initiating QE to curb long-term yields.

4. Lower rates would, in turn, reduce interest expenses, creating a positive feedback loop. Falling rates could partially offset the GDP impact of reduced fiscal spending, ultimately facilitating a soft landing.

Through these maneuvers, the overall impact on GDP would be minimal, with resources shifting from less efficient (government) to more efficient (private sector) areas, while also mitigating inflationary pressures from government spending and tariffs. The challenge, however, lies in achieving that initial reduction in interest expenses. But with Trump’s assertive stance, pressuring the Fed to meet these goals isn’t out of the question. If Trump and Musk can execute this strategy, they could indeed leave a lasting legacy in American politics.