# Risk on or risk off? _A framework for risk in 2025_ February 14, 2025 • Michael Nadeau --- # Risk on or risk off? ## A framework for risk in 2025 Michael Nadeau February 14, 2025 Hello readers, In last week’s report, we noted that the outlook for ‘25 is not as clear as it was in ‘24. The reality is that the markets are processing A LOT of information right now. A new Trump administration. Tariffs and trade negotiations. AI. Inflation. Strength in the dollar. Higher for longer rates. The direction of global liquidity. Deregulation in the finance and energy markets. New regulation for crypto. Anticipation surrounding a Strategic Bitcoin Reserve. It’s a lot to take in. And given that most of the bullish catalysts we projected last year had played out, we began rebalancing to cash in late November into December. But here we are in mid-February. Both Bitcoin and the major indices have been chopping in a range-bound pattern for 3+ months while altcoins have sold off significantly. Meanwhile, we’ve been laser-focused these last few weeks. We want to have conviction. And we want to answer the following question: *Is it time to be risk on again?*  In this week's report, I’m inviting you inside my brain as I grapple with that very question. Topics covered: - [Inflation, The 10-Year, and The Dollar](#inflation-the-10-year-yield-and-the) - [Monetary Policy & Fiscal Policy](#monetary-policy-fiscal-policy) - [Additional Factors](#additional-factors) - [Closing Thoughts](#final-thoughts) Our focus is on the macro setup today. We’re back with part 2 tomorrow — which will focus more on the crypto markets, BTC onchain data, and “cycle awareness.” ***Disclaimer:**** Views expressed are the author’s personal views and should not be relied upon as investment, legal, tax, business, or any other advice. * Let’s go. # Inflation, The 10 Year Yield, and The Dollar ##### Inflation We got the CPI data on Wednesday and PPI yesterday. Both came in hotter than expected. The CPI reading came in at 3% (consensus was 2.9%). January was up .5%, the hottest monthly reading since June of ‘22. PPI came in at 3.5% (3.3% expected). This was the highest reading since Feb. 2023. Core services continue to come down, but we saw an uptick in goods. Data: The Inflation Guy We’ll note that the Fed is more focused on PCE data, with the last reading coming in at 2.8% for core PCE. We’ll have January data on 2/28/25 — but we already have some hints from the PPI data. Here’s what Powell had to say on Wednesday after the CPI print: “*The CPI reading was above almost every forecast. But I would just offer a note of caution on this -- two notes of caution. One is we don't get excited about one or two good readings, and we don't get excited about one or two bad readings. The second thing, though, is we target PCE inflation because we think it's simply a better measure of inflation. And so you need to know the translation from CPI to PCE, and we get more data on that. Tomorrow we'll get the producer price index. So, I think it's always wise. And the people who follow us closely know this, that we'll know actually what the PCE readings are late tomorrow*.” So, what did the PCE components of PPI tell us? As noted, services were down*. * But goods such as diesel fuel (10.4% in January), eggs (44%) were up — which could be reflected in PCE. The markets looked right through this yesterday as equities were up with both the Dollar and 10-year down — the opposite of what you’d expect to see with a higher-than-expected inflation print. As for our view? We’re not concerned about sticky inflation. Why? Truflation (which has more real-time data) indicates that we’re already back down to 2.1%. Of course, the Fed is looking backward. So, they will not react to the current data until next month. Data: Truflation, The DeFi Report What’s next? Data: Steno Research, Bloomberg, Macrobond At a high level, we think inflation fears are misplaced due to the following: - Crude oil continues to trade in the $60-$80 range, where it’s been for nearly 2.5 years now. We believe Trump’s policies to deregulate the sector and “drill baby drill” will keep them there. - We see no major supply shocks or supply chain issues — a major catalyst of the sticky inflation during Covid. - Elon Musk and DOGE are bringing some accountability and transparency to government spending (more on this later in the report). - Despite the unemployment rate dropping to 4% in the latest NFP data, we believe the labor market is tightening. - Efficiencies resulting from AI are creating deflationary pressures in the economy. - We think any Tariffs imposed by Trump will, at worst, create a one-time inflation bump on certain goods. We believe fears over this are overblown. ##### The 10-Year The 10-year hit a local peak of 4.8% on 1/14. It’s now at 4.5%, and we think it’s going to come down further — given our views on growth/inflation. ##### The Dollar The dollar is following the same pattern it did early in Trump’s first term. Below, we can see that it rose sharply in Q4-16 before falling in ‘17. Data: Trading View, The DeFi Report We recently hit a local peak of 110 on 1/13. It’s down to 107.4, and we think it will continue to fall. Why? Trump needs a lower dollar to make US goods more attractive and to push the America First agenda. China needs a lower dollar to stimulate its economy. We think Trump’s bully tactics with Tariffs are setting the stage for trade negotiations. If you read between the lines a bit, it’s possible a deal could be struck in which the US provides military protection and low/no tariffs in exchange for our trading partners buying long-dated US treasuries (possibly 100-year bonds that would not be tradeable but could be redeemed at par if a country needs cash). Bessent is key to this plan as he has indicated that he believes a significant realignment of the global financial system is necessary (due to debts & trading deficits), drawing parallels to the Bretton Woods Agreement of 1944. Of course, the problem that Bessent has to solve today is the one identified by [Robert Triffin](https://en.wikipedia.org/wiki/Triffin_dilemma?utm_source=thedefireport.beehiiv.com&utm_medium=referral&utm_campaign=risk-on-or-risk-off) back in the 60’s. We ultimately believe these negotiations could result in: - a devaluation of the dollar - reduction of debt/GDP - new trade agreements with China and many other trading partners - a big move in liquidity coming from China Given Republican control of both the House and Senate, the incentives are in place to get this done sooner rather than later. # Monetary Policy + Fiscal Policy ##### Monetary Policy If we are correct about inflation, the Fed’s focus will shift back to the labor markets — as was the case during the summer months when the Sahm rule was triggered, catalyzing a 50bps cut in September. Meanwhile… The Fed dot plot currently forecasts two rate cuts later this year. 41% of those surveyed by CME anticipate zero rate cuts. *We think they’ll be 3 to 4. * Why? Inflation is coming down (per Truflation more real-time data) —> labor markets are cooling —> which could lead to growth scares. Given that the Fed is still doing QT, the BTFP program usage has declined, and the reverse repo has been drained from $2.5 trillion down to $100b over the last two years, we think the Fed will be more accommodative moving forward — via lower rates (while ending QT). We expect this to play out in Q2. With that said, we think liquidity will improve even if we see less than 3-4 rate cuts this year. We share why later in the credit markets section. ##### Fiscal Policy Scott Bessent was quite critical of his predecessor’s strategy of financing the federal deficit with short-term debt prior to getting into office. But just last week he confirmed that his Treasury will continue the strategy for “several more quarters.” This acts as “shadow QE” by putting additional highly liquid and widely used collateral into the markets. As noted above, we think Bessent is aligned with Trump on a plan to devalue the dollar and restructure the debt. Tariffs and trade negotiations are all part of the plan. A “Mar-a-Lago Accord” may be in the works. So don’t let Trump’s bluster fool you. In our opinion, it’s all part of a larger plan. ##### DOGE It’s been fascinating to watch Elon Musk and his DOGE team bring some transparency and accountability to government spending. Elon wants to reduce the deficit by $2 trillion, a wildly ambitious goal. We don’t think this is possible, and even Elon has admitted that $1 trillion would be massive progress. We think it’s more likely that he’ll be able to cut some discretionary spending/waste here and there while recalibrating the culture in DC. For example, the budget for USAID — an international development agency in hot water recently — has a total budget of $58b for 2025. If this entire program were to be eliminated, it’s still just a drop in the bucket. With that said, given that 45% of job creation came from the gov’t sector + healthcare over the last two years, we think DOGE could marginally add to labor market weakness this year — which could lead to rate cuts and money printing to offset slowing growth. See, this is the problem with Elon’s ambition goal. He seems to think you can just reduce spending, improve transparency, balance the budget, and move on. That’s how it works in business. But that’s not how it works for a country with $36 trillion dollars of debt. If Elon were successful, the trade-off would be a recession or depression. As a bit of an aside — if you’re seeking an alternative view regarding DOGE’s goal of balancing the budget, we would recommend checking out “Finding the Money” documentary by Stephanie Kelton. We wrote about it [here](https://thedefireport.io/research/studying-mmt-to-become-a-better-investor?utm_source=thedefireport.beehiiv.com&utm_medium=referral&utm_campaign=risk-on-or-risk-off). # Additional Factors ##### ISM Data: Micro Macro, The DeFi Report We can see above that the ISM recently broke through the all-important 50-level — indicating the *start *of a new business cycle. Yes, I said start. ISM cycles tend to mirror global liquidity cycles, which mirror crypto cycles. In each of the last few regimes, the ISM hit 50, was rejected, and then broke out firmly. We believe we just had the firm breakout, signaling expansion — which typically coincides with an increase in global liquidity. Of course, this happens to correlate to “altseason…” Data: Global Macro Investor via Julien Bittel ##### Credit Markets Credit spreads remain at historically low levels. Data: Federal Reserve FRED The % of banks tightening lending standards looks quite healthy. Data: Federal Reserve FRED Meanwhile, banks are “dancing in the streets” according to Jamie Dimon — who recently expressed optimism regarding potential regulatory changes that could significantly expand credit availability under the Trump administration. Investors should pay attention to this. The markets were reminded in ‘23 - ‘24 that it’s not just the Central Bank that can “print money.” The Treasury (via Fiscal Policy) can also print money by running massive deficits. Of course, private credit via bank lending is the 3rd leg of the stool. Banks can “print money” via lending. Data: Federal Reserve FRED The start of a new credit cycle coming from the private sector (banks) does not seem to be something that is on the market’s radar today. ##### Small Business Optimism & Capex Expenditures Small business optimism spiked massively after Trump’s election victory, which is consistent with what we saw back in late ‘16/early ‘17 after his first nomination. Data: National Federation of Independent Business Meanwhile, the Philly Fed Capex Index is spiking, which is consistent with small business optimism and the ISM breaking through 50. The takeaway? *It appears that a new business cycle is just getting started. * This is a contrarian view as far as we’re concerned. We simply follow the data. Data: Federal Reserve of Philadelphia ##### China Rates in China are dropping like a rock as their economy spirals into deflation. Again, this is consistent with what we saw early in Trump’s first term. After the dollar was devalued, China eased conditions — which increased global liquidity and helped fuel the 2017 parabolic move in BTC. The same setup is in play today. Data: Trading Economics # Final Thoughts Given the performance of the S&P 500 over the last few years, investors are skeptical that markets can have another good year. Of course, when we add in the many layers of uncertainty swirling out there right now, it’s not surprising that markets have chopped for 3 months +. It felt like risk was to the downside in December/January. Of course, we’ve had three straight “Monday scares” with Deepseek/AI and Tariffs. But the markets have held up quite well. The wall of worry is being climbed. Bad news doesn’t seem to land — as we saw with yesterday’s PPI print. And so now the risk is starting to move toward the upside. Why? We’re having a tough time building conviction regarding concerns related to tariffs, inflation, rates, etc. And the data is telling us we are at the *start *of a new business and cycle. Not the end. Could we chop for longer? Revisit the range lows? Absolutely. But we’ve started to add risk back into the market, for all the reasons stated here. We still believe a proper altseason is yet to come. Remember. It’s necessary for investors to be chopped up, impatient, and lose their spirit before the next move up. Feels like we’re getting close. Stay tuned as we’ll follow up tomorrow with a focus on the crypto markets, an onchain data update, + assets we like for ‘25. Take a Report. And Stay Curious. ***Disclaimer****: Individuals have unique circumstances, goals, and risk tolerances, so you should consult a certified investment professional and/or do your own diligence before making investment decisions. The author is not an investment advisor and may hold positions in the assets covered. Certified professionals can provide individualized investment advice tailored to your unique situation. This research report is for general educational purposes only, is not individualized, and as such should not be construed as investment advice. The content contained in the report is derived from both publicly available information as well as proprietary data sources. All information presented and sources are believed to be reliable as of the date first published. Any opinions expressed in the report are based on the information cited herein as of the date of the publication. Although The DeFi Report and the author believe the information presented is substantially accurate in all material respects and does not omit to state material facts necessary to make the statements herein not misleading, all information and materials in the report are provided on an “as is” and “as available” basis, without warranty or condition of any kind either expressed or implied.*