The Deficit closed by $250 billion in the last four months and nobody is talking about it.

Macro Musings

This is my final post before the family road trip, sadly, it doesn’t have a new small cap idea. Damn you Macro Musings! I will be back before the beginning of August.

There was a bit of news that slipped under a lot of people’s radars. It doesn’t fit with the narrative that Trump is going to increase the deficit by $5 Trillion or whatever the nonpartisan congressional budget office says. I have been keeping an eye on the actual deficit as it comes out month after month, not the projections of economists. There are timing effects that can throw off the data, but if the pattern continues, timing won’t be able to explain the changes that we are seeing.

January 2025 deficit -$127 billion vs 2024 -$22 billion = $105 billion worse

February 2025 deficit -$307 billion vs 2024 -$296 billion = $11 billion worse

March 2025 deficit -$163 billion vs 2024 -$237 billion = $73 billion better

April 2025 surplus +$258 billion vs 2024 +$210 billion = $47 billion better

May 2025 deficit -$314 billion vs 2024 -$347 billion = $33 billion better

June 2025 surplus +$26 billion vs 2024 -$71 billion = $97 billion better

Trump was inaugurated on January 20th, and it takes a few weeks for things to actually start happening. Longer than a few weeks if a handful of judges issue nationwide injunctions which the Supreme Court has recently ruled they did not have the authority to do.

But the pattern is pretty clear, the deficit versus 2024 is improving. Depending on where you want to draw the line and start attributing credit to the new administration, the last four months have seen an improvement over 2024 of $250 billion. That would annualize to a $750 billion swing in deficit creation under the first year of Trump versus the last year of Biden. There is still room for payments timing changes to throw these numbers off, so I’m not staking my reputation on a $750 billion prediction, but that is the current run rate.

The deficit in 2024 was about $1.8 trillion, Trump might be on a run rate to have a deficit closer to $1 trillion. (Note: the official fiscal year 2025 deficit will be higher, the fiscal year ends in October) Trump wants the Federal Reserve to cut interest rates and save another $400 billion on interest expense, which would bring the deficit closer to $600 billion, down from $1.8 trillion. Again, with congress’ fiscal year ending in October, the changes that are happening today won’t be revealed in the full year 2025 fiscal data. But if you watch the monthly data, wowzers.

I believe this is important because the current market narrative is that the US is on an unsustainable path, therefore inflation is inevitably coming back, therefore the 10-year treasury rate must stay high. If that is the current situation, then the new Fed Chair cutting rates would imply even more inflation, which would likely cause the 10-year treasury to go up and not down. This is the prediction of the smartest guys in the room at the moment, Trump will get a new Fed Chair who will cut the overnight rates, and the yield on the 10-year treasury will go up.

But, if by the time the new Fed Chair took office, we were on a $1 trillion annual deficit run rate, and his actions lowered that to a $600 billion annual deficit, the market might not be convinced that the US is on an unsustainable path. If our path isn’t unsustainable, some of that inflation premium can come out of the 10-year treasury. That would be a world where the new Fed Chair could cut interest rates, and the 10-year treasury could fall instead of rise.

So the market consensus on whether or not the US’ fiscal situation is circling the toilet bowl plays a huge part in interest rate price discovery. When that narrative changes, there could be a lot of new winners and losers in the marketplace.

Allow me to clarify, I am not in favor of artificially low interest rates blowing bubbles of malinvestment, it’s not what I want to see happen. But the dominant market narrative from the nonpartisan congressional budget office seems to be a bunch of hooey. When enough hard data rolls in, if this trend holds, the market might be in for a surprise that the United States is on a much more sustainable fiscal path than most participants realize. With that threat lifted off the bond market, the 10-year treasury might even come down a smidgen. That outcome isn’t on many people’s radars, most people in finance circles seem to still believe the narratives created by the legacy media, especially when they treat Trump like a buffoon, which he is at times.

This scenario, where a new Fed Chair cuts interest rates and the 10-year treasury rate falls due to our sustainable fiscal path will be cut short by the boom it creates. While people are relieved that inflation won’t be coming from fiscal deficits, the re-leveraging of the banking system will drive prices higher. So we might enjoy a year, eighteen months, or even two years of euphoria where pundits on CNBC use the term “Goldilocks” too often, but eventually inflation will drive the 10-year treasury higher again, and the Federal Reserve might feel that it has to tighten liquidity.

In the euphoria phase, gold would suffer although perhaps Chinese buying is enough to keep it afloat, the housing market would unfreeze but maybe not boom due to the population decrease from immigration enforcement, consumer discretionary would thrive, and industrial activity would drive up commodity demand. But in the inflationary phase, gold would run again, and rising mortgage rates would once again squeeze the housing market, cutting off the marginal spending that drives cyclical booms. That is approximately what the next three years could look like, based on the last four months of hard fiscal data. All of that would be wrong if Trump’s budget really is as profligate as the narrative makers claim it is, and the deficit starts to increase again. But this current run rate, doing $750 billion better in the twelve months from March 2025 to February 2026, is enough to upset the dominant market narrative that when the new Fed Chair cuts rates, the 10-year will rise.

For phase I, the revelation of fiscal sustainability, any interest rate sensitive sector should rally, even if the rally reverts a year or so later. Perhaps the most degenerate place to be would be Opendoor (OPEN), but Rocket Companies (RKT) is much safer and with less torque. I have been shocked by (SOFI)’s recent runup, and my suspicion is that it will be due for a pullback, but I could easily be wrong. Consumer Discretionary is pretty beaten down, and should rally hard on the liquidity provided by the unfreezing of the housing market, I particularly like Newell Brands (NWL), at some point it has to find a floor. Traditionally, materials and industrials do well in this sort of environment, but that rally has already begun, and it’s hard to tell how far it has to go. One part of industrials that hasn’t rallied yet is transports, and I still think Heartland Express (HTLD) is an inevitability.

Energy would typically rally hard in phase II, when the inflation starts to come from the over-heating and re-leveraging economy. The fear of the next hiking cycle and rising interest rates would start to hurt the real estate and consumer discretionary sectors again, as well as any bond proxies, such as utilities. Materials would likely benefit due to the commodity driven inflation, even though textbooks would tell you that this part of the cycle is bad for that sector.

If the future happens somewhat in the way I have described it above, it would mean that it would be a great time to be nimble, and to be willing to rotate frequently. There might be some room left for current winners to keep rallying, I’m terrible at timing momentum. Alta Equipment Group (ALTG), Sibanye Stillwater (SBSW), and Centrus Energy (LEU) have been going very strong. I took some profits in (ALTG) and (LEU), but I haven’t taken any from (SBSW) yet. I plan on adding to (NWL), (HTLD), and (RIG) less because of any hard analysis, and more because I have a gut feeling that they should do something soon enough. I think it’s early for energy generally, but offshore contracting should be ramping up now as those contracts are negotiated six to nine months before their start dates. I would wait until after Consumer Discretionary has rallied to start adding to energy producers in a big way.

Over the next year or two, I expect $LEU and $ALTG to give me a chance to get back in. I could easily be wrong. But I don’t sweat a missed opportunity, because I can always find more. Taking profits is hard, and if I am wrong, it’s a great way to have angry readers unsubscribe.

I am still an inflationista, and I do think that sustained inflation is an inevitability. But I am shocked by the change to the deficit these last four months, as well as the total lack of attention that it’s getting. I understand hate, I really do, but why would people hate Trump so much that it blinds them to the data they need to position their portfolio?

Again, this timeline can turn out to be wrong in any number of ways, foremost of which is if the new budget reconciliation starts increasing the deficit again. But I believe that Trump wants a different legacy than that, the big payola bills come from career politicians with palms to grease and favors to repay. Trump seems to be only worried about giving his voters what they want, and how the history books will portray him. We certainly live in interesting times.

Opendoor (OPEN):

Rocket Companies (RKT):

Newell Brands (NWL):

Heartland Express (HTLD):

Centrus Energy (LEU):

Alta Equipment Group (ALTG):

Sibanye Stillwater (SBSW):

Transocean (RIG):