Posted:July 9, 2025
Categories: Quarterly Commentary, Markets, Bond Market, Market Update, Stock Market, US Dollar, US Treasuries
The second quarter of the year experienced significant volatility in many markets influenced by a confluence of economic, geopolitical, and macroeconomic factors. Many markets continue to press up against all-time highs, including US stocks, European equities, and other global stocks, as well as Bitcoin, gold, and the global liquidity and money supply. Before I review some market action, I’d like to touch on the passing of the budget bill in Congress.
One Big Beautiful Bill
The timing of the bill is interesting because my two teenage sons are leaving on Sunday for a camp in Washington, D.C., where they will learn about how the government works, including the process of drafting and passing bills. One of my sons had to create two sample bills that may potentially get discussed in a “draft congressional” setting. The “How to Write a Bill” template guided them through the process of writing a bill, including a section on how the bill would be funded.
I downloaded the bill this week, and it’s massive. Early estimates from this bill suggest that it will keep the budget deficit at around 6-7% of Gross Domestic Product (GDP) and increase total debt to well over 125% of GDP over the next 10 years. Interest alone is expected to rise to over $2 trillion per year. While this will add to the stock of government debt, all things being equal, deficit spending is stimulative to markets, at least in the short to intermediate term. I’ve written about this idea through a phrase called “Fiscal Dominance.”
Fiscal Dominance refers to large and rising government debt and deficits, which create inflationary pressures that “dominate” central bank monetary policy actions. These pressures create a “crowding-out” effect, hindering the central bank’s ability to control the economy and inflation through interest rate actions.
As with the central bank lowering interest rates to stimulate and liquify markets, deficit spending also creates liquidity. When one person spends, in this case, the government, this becomes another person's income or earnings. This dynamic is important in understanding economic activity. For instance, if there is extensive credit creation, such as when the government borrows, people tend to spend and earn more, leading to a rise in asset prices. While deficit spending is stimulative in the short term, it can become risky as debts accumulate. This can create a cyclical pattern of borrowing and spending, a phenomenon that Ray Dalio has extensively written about, known as the long-term debt cycle.
To be clear, the US continues to possess the power of the global reserve currency, and our debt and capital markets remain the most liquid and deep in the world. Even after all the threats over “de-dollarization,” our debt continues to be snapped up by foreign investors, as shown in Figure 1 below. Foreign-held debt exceeds $9 trillion.
Figure 1: Federal Debt Held by Foreign and International Investors, 2000–2024
Source: FRED, Federal Reserve Bank of St. Louis
Federal Reserve Independence
The independence of the Federal Reserve Chairman is at risk as President Trump continues to suggest the Fed should lower interest rates by as much as 3%. This is an incredibly controversial topic. Some believe we should abolish the Fed, while others believe it’s an important institution that fosters smooth capital markets. We’re very far removed from 1913, when the Fed was created. Tearing this institution down overnight would likely be too great a shock for markets. Capital has flocked into our capital markets due to the confidence investors have in our companies and capital markets. Removing the Fed's independence may hinder our ability to attract capital, potentially even undermining the rule of law.
Trump will eventually get his guy when Powell’s term is up in May 2026. We may be facing a Nixon/Arthur Burns situation, but we’ll have to wait and see. But remember that the Fed lowered short-term interest rates by a total of 1% at the end of last year. At the same time, the 10-year US Treasury bond, a rate not under the Fed's control, increased by 1% over the same period.
Stocks
The S&P 500, after peaking at 6,100 in February, experienced a sharp sell-off in April, dropping to 4,800 following the "Liberation Day" tariff announcements. The tech-heavy NASDAQ also saw a similar initial decline. This sell-off was accompanied by a decrease in the dollar and rising bond yields, a shift from historical norms where the dollar would typically strengthen as a safe haven during market panic.
Subsequently, the market staged a robust recovery and rally throughout May and June, with the S&P 500 rebounding to 5,800-5,900. The market hit an all-time high in early July. Many global markets are also near their all-time highs. The valuation gap between US and non-US stocks, along with a falling dollar, has aided international stocks in 2025 as they’ve led stock markets so far this year.
The “Buffett Indicator,” which compares the stock market to the GDP ratio, recently hit an all-time high, as shown below.
Figure 2: The Buffett Indicator
Source: Longtermtrends.com
Bonds
The yield curve steepened, particularly at the long end of the curve. The 10-year Treasury yield experienced significant increases, rising from 3.90% in early April to 4.60%, and then reaching 4.52% by late May, before dropping to 4.23% by the end of the quarter. The aggregate bond index is up 4% for the year and is now 6.1% higher year-over-year. The rise in long-term yields is not isolated to the US; it's a global phenomenon, with Japan, Germany, and the UK experiencing even larger increases in rates.
US Dollar
The US Dollar Index (DXY), which measures the dollar's value against a basket of major currencies, experienced a significant decline, dropping from 110 to around 100 and even reaching multi-year lows of 97.5 or 98. This marked the worst first half for the dollar in approximately 40 years. Indeed, Trump’s tariff policy has had a significant impact on the dollar along with the aforementioned fiscal situation. The quarter also saw a reversal of the massive inflow of capital to the United States over the past number of years. While some experts view this as a cyclical pullback, others suggest it marks the beginning of a more profound structural shift. I tend to fall into the cyclical camp.
Commodities
Despite rising geopolitical concerns, oil prices remain around $60 to $70 per barrel. Keeping a lid on oil prices is key to addressing inflation concerns. Gold continues to show strength and is currently consolidating around the $3,200 to $3,500 per ounce levels. Silver broke out during the quarter and is now above a key resistance level of $35. The gold-to-silver ratio sits at around 90.
Conclusion
Risk always lurks around the corner; high and rising debt levels, trade and capital wars, and geopolitical fragmentation, to name a few. For now, most markets remain in an upswing. Additionally, despite periods of stress this year, overall global liquidity conditions and the likelihood of lower rates are supportive of risk assets.
Quarterly Data
Historical Market Returns - Year by Year
Quotes of the Month
“The rate of interest expresses the degree of impatience with which men and women discount the future.” Irving Fisher
References
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