2025 may be a year to play defense
Last week we talked about the federal government's math problem. The U.S. Treasury must borrow a lot of money, by issuing bonds, during 2025. Data and estimates from the Federal Reserve indicate about $10 trillion. These bonds will be issued into a higher interest rate environment, likely increasing government interest expenses by hundreds of billions of dollars. This increased interest expense could have profound implications for government finances and operations, and if not carefully managed, profound implications for the overall economy and financial markets as well.
In prior economic cycles, some of this debt would be monetized, which means the Federal Reserve would initiate policies to expand the money supply to accommodate the process of issuing bonds, which is done through a complicated auction process. With inflation still running above desired levels, however, aggressively expanding the money supply could reignite higher inflation, causing financial stress among the population and political stress in the government. Said simply, the size and timing of this math problem has left the government and the Federal Reserve boxed into a corner, and the new administration is very aware.
Like much about the new Trump administration, the policy response to this fiscal challenge is shaping up to look quite unorthodox by recent comparisons. After analyzing recent comments and policy initiatives from the administration, I believe the strategy will be multifaceted and is likely to heavily influence financial markets for the next couple of quarters. Let's go through a couple of the concepts.
First, the administration has made it clear it would like to see lower interest rates. This week President Trump weighed in on the Federal Reserve's most recent policy decision to keep interest rates steady, by encouraging the Fed to cut interest rates to support his tariff policies. Also, over the past few weeks, Treasury Secretary Bessent has repeatedly expressed the intention of the administration to target lower yields on the benchmark 10-year U.S. Treasury.
While the effectiveness of the President's encouragement remains to be seen, and Treasury policies to target lower 10-year yields would be unconventional and, in many ways, experimental, I would find it difficult to bet against these coordinated efforts.
Second, President Trump is clearly serious in his intention to use tariffs to increase government revenue and rectify what he considers trade injustices against the United States. Based on recent stock market reactions, tariffs are obviously not popular on Wall Street, and as tariff policy continues to be revealed, evolved and implemented, I expect continued uneasiness and volatility from investors. With the President now touting April 2 as some sort of tariff "liberation day," this coming week could prove very interesting from a tariff policy perspective.
Third, the new administration will attempt to pivot the economy from being dominated by government intervention and federal spending, to an economy handed off and supported by the private sector. According to data from the Mises Institute, during the Biden administration the federal government became a primary driver of job growth in the U.S. with the percentage of new government jobs going from around 3% in early 2021 to as high as 58% of all new jobs in late 2023.
This hiring spree contributed to record high federal spending and deficits, with total post-COVID crisis federal spending at around $6.75 trillion in 2024, equaling about 23.5% of the total U.S. economy (the long-term average is about 20%) and driving record deficits of almost $2 trillion.
The Trump administration response, led by DOGE, involves slashing federal jobs, programs and even entire federal agencies. While the rhetoric on this process from both ends of the political spectrum has reached a feverous pitch, I say the process in some form was ultimately inevitable. The fiscal math problem and the fast-approaching federal debt challenge makes shrinking government and reducing federal spending highly necessary. Like it or not, the math says the money is running out in Washington, and the process was never going to be easy or pretty.
So, what do the rest of us who just want to invest to send our kids to college and hopefully one day retire do in this type of highly charged fiscal and political morass? My answer for 2025 is, be careful. Unlike recent years when we enjoyed relatively easy stock market gains and stable interest rates, 2025 looks to be a year of economic and financial market transition. Transition leads to uncertainty and financial markets typically don't cope well with uncertainty.
We've already experienced one technical market correction this year, I won't be surprised to see more, and calls for recession are already in the ether. Sometimes offense rules the day, and sometimes defense. To me, 2025 looks like a year for defense, which means more active rebalancing, a slant toward value stocks and high-quality bonds and a high level of resolve for investors deciding to stay in the game. Transitions are never simple, but they are sometimes necessary.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
