Trump's Conspiracy: Run It Hot

Analysis of Non-Farm Payroll (NFP) Data

In July, the U.S. non-farm payrolls added only 73,000 jobs, far below the market expectation of 110,000. Worse still, the job additions for May and June were revised down by a total of 258,000, falling to just 19,000 and 14,000, respectively. Coupled with a weakening manufacturing PMI, this has raised investor concerns about a rapid cooling of the labor market and an economic slowdown. The S&P 500 has retreated 3% from its peak, and the VIX volatility index has risen above 20 for the first time since June.

We believe that this round of adjustment has long been predictable. Previously, the S&P 500 recorded the longest period above the 20-day moving average in nearly a century, and since "Liberation Day," a basket of low-quality, unprofitable companies has significantly outperformed the market, reflecting overheated short-term sentiment. As we enter a low-volume, high-volatility summer, a momentum pullback is almost inevitable. In fact, these speculative stocks peaked as early as July 21, ahead of the non-farm data release. Figure: The S&P 500 recorded the longest period above the 20-day moving average in nearly a century since April

However, the significant downward revision of the non-farm data has shifted market concerns beyond technical adjustments to questioning the fundamentals of the labor market. We believe this is not the time to follow the bears, for three reasons:

1. Weak Employment in State and Local Governments is a Lagging Effect

The main reason for the downward revision in employment data is the reduction of jobs in state and local government sectors, which we believe stems from the lagging impact of the "Department of Government Efficiency" (DOGE) reforms. Although DOGE only targets federal employees, its budget constraints and economic spillover effects can transmit to local governments. For example, large-scale federal layoffs in March 2024 led to a simultaneous decline in federal and local jobs the following month; while the layoffs at the beginning of 2025 initially only affected federal jobs, local employment remained strong until this data revision. This indicates that the recent data may only reflect the lagging effects of previous federal cutbacks. Importantly, since April, government departments have stopped layoffs, so we expect the weakness in public sector employment to soon reverse—just as it did in the second half of 2024. Figure: Unprofitable companies significantly outperform the market (left) Lagging impact of DOGE reforms (right)

2. Stable Unemployment Rate, Structural Tightening in the Labor Market

Despite the non-farm data weakening for three consecutive months, the unemployment rate remains stable at 4.2%. Excluding the anomalous increase in the population entering the labor market, the unemployment rate in July could even drop to 4.0%. This divergence between job additions and the unemployment rate confirms our previous view—that Trump's tightening immigration policies are structurally tightening the job market by limiting labor supply. In this context, the slowdown in job growth may not reflect weakened demand but rather indicate a new equilibrium. The recent rebound in wage growth further supports this interpretation, indicating that the labor market is indeed tightening—even if the overall employment data does not seem to suggest so. Figure: Anomalous increase in the population entering the labor market (left) Structural tightening of labor supply (right)

3. Other Indicators Show Employment Resilience

Setting aside the weakness in non-farm employment data, several other labor market indicators continue to show inherent resilience. Private sector employment rebounded sharply in July after declining for two consecutive months. Meanwhile, the NFIB small business hiring plans have significantly rebounded since May, suggesting that future JOLTS job openings may increase. More importantly, the rise in the unemployment rate primarily comes from new entrants and returnees to the labor market, rather than permanent job losers, which does not align with historical recessions. Figure: Rebound in wage growth (left) Significant rebound in private sector employment (right) Figure: Noticeable rebound in hiring plans (left) Increase in the population entering the labor market does not indicate recession (right)

In summary, we believe that the weakness in non-farm employment primarily reflects constrained labor supply and the lagging effects of DOGE, rather than a signal that the economy is about to fall into recession. In fact, the weak non-farm data provides a strong rationale for the Trump administration and the "dovish faction" within the Federal Reserve to push for rate cuts at the FOMC.

At this moment, Federal Reserve Governor Christopher Waller, who holds a dissenting opinion, appears very prescient. In a speech on July 17, he pointed out:

"My final reason for supporting a rate cut now is that, although the labor market appears acceptable on the surface, when considering the expected data revisions, private sector job growth is nearly stagnant, and other indicators suggest that the downside risks to the labor market have increased."

While we do not fully agree with Waller's pessimistic assessment of the U.S. labor market, the latest non-farm data undoubtedly strengthens his position within the Federal Reserve to push for a quick restart of rate cuts. If our judgment is correct—that the current weakness is only temporary—then a rate cut in September may occur against the backdrop of a resilient labor market, providing strong support for risk assets. Figure: Weak non-farm data strengthens the probability of a September rate cut

In this context, we believe that the recent market pullback is not the beginning of a broader decline, but rather a healthy momentum correction after excessive exuberance. Therefore, investors should maintain a constructive view and see the adjustment as an opportunity for positioning rather than a risk signal.

One Big Beautiful Bill Act: The End of the Fiscal Austerity Narrative

Given that the One Big Beautiful Bill Act (OBBBA) has been widely discussed by investors, we will not reiterate its specific provisions and long-term impacts on U.S. fiscal sustainability. For macro investors, there is only one key takeaway: the comprehensive failure of OBBBA and the "Department of Government Efficiency" (DOGE) plan has completely ended the narrative of U.S. fiscal consolidation.

According to the latest forecasts from the Committee for a Responsible Federal Budget, the U.S. federal deficit is expected to average about 7% of GDP over the next three years, more than double the 3% target set by Treasury Secretary Bessent for 2028. From another perspective: if the unemployment rate remains around 4% in 2026, the "deficit level corresponding to each 1% unemployment rate" will rise to a three-year high. In other words, despite the Trump administration's verbal criticism of the fiscal extravagance during the Biden era, it is, in fact, pursuing the same aggressive fiscal policies while the economy remains robust. Experienced investors should not be surprised by this, as Trump embraced counter-cyclical fiscal expansion during his first term. Figure: The federal deficit rate for U.S. stocks is expected to average 7% of GDP over the next three years Figure: The deficit level corresponding to each 1% unemployment rate will significantly increase Figure: Trump restarted counter-cyclical fiscal policy during his first presidential term

Considering the rising deficit expectations, the only defensible aspect of the Trump administration's fiscal strategy is to shift focus to the denominator—nominal GDP. Treasury Secretary Bessent's recent remarks reflect this shift: "The key is that economic growth must outpace debt growth. If we change the trajectory of the nation's and the economy's growth, we can stabilize the finances and resolve the debt through growth."

A recent memo from the White House echoed this logic, claiming that OBBBA would reduce the deficit by $4.5 trillion compared to the current policy baseline—not through spending cuts, but by promoting economic growth. A similar narrative was also mentioned by Stephen Miran, chairman of the President's Council of Economic Advisers, who believes that the combination of tax cuts and tariff revenues will drive annual GDP growth to 3.2%, thereby alleviating fiscal pressure.

In our view, these statements mark a clear shift in the Trump administration's fiscal stance: no longer centered on spending cuts, but prioritizing strong economic growth to reduce the deficit rate. Although many economists and investors remain skeptical of this "growth-based debt reduction" strategy, developments over the past few years have provided some support for it. Since 2020, the U.S. government's debt-to-GDP ratio has declined and remained relatively stable, largely due to the unexpectedly strong nominal growth during the post-pandemic economic recovery. Figure: Strong nominal growth helps the federal government "de-leverage"

Therefore, before the midterm elections next year, the path most likely chosen by the Trump administration to address the deficit issue is to let the economy run hot, betting that strong nominal GDP growth can alleviate fiscal pressure and reduce the debt burden.

Musk's "American Party"—Potential Political Risks for Trump

After the passage of OBBBA, Elon Musk announced the establishment of a new political party—the "American Party," claiming its goal is to break the two-party system and appeal to the "80% of Americans alienated by ideological extremism." Although still in its infancy, the "American Party" is expected to focus on fiscal prudence, government efficiency, and technological innovation.

As early as December 2023, in our report "The End of the American Two-Party System?", we pointed out that neither of the two major parties in the U.S. adequately reflects the preferences of centrist voters. An increasing number of Americans are beginning to reject party affiliation, as reflected in the significant rise in the number of "independent" voters during elections, with party identification continuing to weaken. Figure: The two major parties in the U.S. fail to adequately reflect the preferences of centrist voters

Moreover, Trump and Biden are not only the oldest presidential candidates in U.S. history but also rank among the least popular candidates in history. The dual collapse of party loyalty and presidential approval ratings led us to conclude that a reshuffling of the American political landscape is almost inevitable. Figure: Trump and Biden are among the least popular presidential candidates in U.S. history Can Elon Musk's "American Party" rise to become a competitive political force in the U.S. by taking advantage of the changing policy landscape? The mainstream view suggests that the possibility remains low for three main reasons: 1. Institutional Barriers—The U.S. "winner-takes-all" electoral system poses a natural obstacle to third parties. Under the "simple majority" rule, if a third-party candidate cannot win any state, they may still fail to secure any electoral votes even if they receive millions of votes nationwide. The 1992 campaign of Ross Perot is a typical example: he garnered 18.9% of the national popular vote (the highest for a third-party candidate since 1912) but failed to win any states due to the electoral college rules. Notably, Perot's campaign platform focused on fiscal consolidation and debt reduction, highly similar to the claims of Musk's "American Party." 2. Trump has already played the "third-party role"—Trump did not run as an independent candidate; instead, he directly "took over" the Republican Party, transforming it into a populist, anti-establishment platform. The resulting "Make America Great Again" (MAGA) movement reshaped the core issues of the Republican Party, including trade, immigration, and foreign policy. In other words, the "political alternative" Musk is trying to provide has largely already been realized by Trump. Historical experience shows that once a strong outsider movement gains a foothold, it will be extremely difficult for another emerging force to gain influence in the short term—especially in the aftermath of such a political transformation. Lacking a distinct ideological foundation or grassroots mobilization capability to rival MAGA, the "American Party" may struggle to win the hearts of the people. 3. Voters vote for people, not abstract ideas—For the "American Party," this presents a dual challenge: first, Musk, being born in South Africa, is constitutionally ineligible to run for president; second, his personal popularity has significantly declined since the beginning of this year. If a political newcomer is both legally barred from running for president and lacks public support, the likelihood of gaining voter backing will be greatly diminished—after all, compared to complex policy details, American voters are often more easily swayed by personal charisma and individual image. In the U.S., successful political movements almost always revolve around charismatic individuals rather than relying solely on abstract platforms. Lacking a qualified and popular candidate to embody its claims, the "American Party" will face severe challenges in gaining national influence. Figure: Musk's personal popularity has significantly declined since Trump took office While the likelihood of the "American Party" becoming a force capable of overturning the two-party system is extremely low, its disruptive threshold is much lower, posing a substantial threat to the Republican Party's slim advantage in Congress. Musk has hinted that the party could focus its efforts on 2-3 Senate seats and 8-10 House seats, influencing key legislation in marginal districts. The Cook Political Report indicates that three Senate seats and 18 House seats are expected to be "competitive" in 2026, providing a realistic path for the "American Party" to exert influence.

However, we believe that a more likely scenario is not the "American Party" winning seats but rather changing the outcome by siphoning off Republican votes. Polling from Echelon Insights shows that without the "American Party" running, the Republicans lead by 1 percentage point in the midterm election congressional popular vote; if the "American Party" runs, the Republican advantage will be erased, and the Democrats could lead by 4 percentage points. Figure: The "American Party" is likely to become a "spoiler" in the midterm elections

Notably, the "American Party" currently has "tailwinds" in its favor: in recent years, public concern about federal spending and budget deficits has significantly increased. Since Trump's presidency, the proportion of Americans who view the federal deficit as a "major national issue" has continued to rise. If "reducing the deficit" remains one of its core platforms, then the current public opinion environment is indeed timely. Figure: American public concern about budget deficits has significantly increased

In summary, while we have doubts about the long-term viability of the "American Party," its potential to act as a spoiler and impact Republican election prospects in the 2026 midterm elections cannot be ignored, constituting a real political risk for Trump.

So, what does this mean for investors?

With the risk of losing midterm election advantages, the Trump administration and the Republican Party have a strong incentive to push for more legislation in the next 12 months. House Speaker Mike Johnson and an increasing number of Republican voices have proposed two rounds of budget reconciliation plans for this fall and next spring. Although details have not been disclosed, these proposals are expected to cover additional tax cuts, defense spending, some spending cuts, and energy provisions.

These reconciliation legislations could bring further fiscal stimulus, although not as large as OBBBA, but we judge that the core strategy of the government remains to maintain high economic growth, allowing voters to tangibly feel the benefits before the midterm elections. This strategy may include not only legislative advancement but also the continuation of regulatory easing, maintaining upward momentum in asset prices (as Trump himself has claimed), and—perhaps most critically—pressuring the Federal Reserve to cut rates. This brings us to the next topic.

Firing Powell? The Focus is Not Here

Recently, President Trump has noticeably escalated his criticism of Federal Reserve Chairman Jerome Powell. On July 16, reports indicated that Trump had shown a draft letter to fire Powell during a meeting with House Republicans on July 15. Although Trump later clarified that he is unlikely to actually dismiss Powell, concerns about potential personnel upheaval at the Federal Reserve are intensifying in the market.

We previously predicted that if Trump is re-elected, he would use political capital and public opinion influence to force Powell to resign voluntarily—this scenario is not without historical precedent, as President Truman once forced then-Federal Reserve Chairman Thomas McCabe to resign. However, we remain skeptical about whether Powell will lose his position before his term ends in May 2026. Our judgment is that Powell is likely to withstand Trump's political pressure and continue to serve for the next 10 months.

From Powell's perspective, given that the rift with Trump is irreparable, the most advantageous choice for him is to hold his position and be remembered in history as "the last chairman to defend the independence of the Federal Reserve." Succumbing to Trump's demands would not only tarnish his central banking career but also overshadow his significant achievements in controlling inflation and stabilizing employment.

For investors, the core signal of this Federal Reserve personnel turmoil is that—regardless of whether Powell leaves early, his successor will be a clearly politicized dove. This view is also supported by legendary investor Paul Tudor Jones. Among the four leading candidates considered to succeed Powell, three—Federal Reserve Governor Christopher Waller, former Federal Reserve Governor Kevin Warsh, and National Economic Council Director Kevin Hassett—have either clearly shifted to dovish positions or openly supported Trump's calls to fire Powell.

Waller has explicitly stated that a rate cut should occur in July and believes that the federal funds rate should stabilize around 3%. Warsh has publicly echoed Trump's criticisms of the Federal Reserve, stating that "Trump has reason to pressure the Federal Reserve in public." Hassett has argued that "the Federal Reserve has no reason not to cut rates now," even suggesting that Trump could directly remove Powell due to controversies surrounding the Federal Reserve's facilities renovation.

The fourth potential candidate, Treasury Secretary Scott Bessent, is relatively cautious and has advised Trump not to attack Powell. However, on interest rate policy, he clearly aligns with Trump, believing that the Federal Reserve should lower rates in the current mild inflationary context.

Although Powell's official term will last until May 2026, the Trump administration is likely to appoint a new chairperson within months—especially in light of Adriana Kugler's resignation creating an opportunity. This appointment will create a "shadow chair," effectively marginalizing Powell in public opinion and market attention.

Unless inflation significantly rebounds (given the ongoing decline in housing inflation, we believe this risk is low), the rate-cutting path favored by Trump will ultimately be realized through a politicized Federal Reserve. It can be said that the Federal Reserve has clearly embarked on a politicized path and will ultimately execute Trump's political agenda of lowering rates, regardless of the macroeconomic fundamentals. Appointing a super-dovish Federal Reserve chair will be the final piece of the puzzle for Trump to promote "Run It Hot" before the midterm elections. Figure: The ongoing decline in housing inflation is expected to keep overall inflation stable

Investment Implications

Overall, we believe that the Trump administration intends to "Run It Hot" over the next 12 months to enhance the Republican Party's chances in the midterm elections. The core strategy is to keep the Federal Reserve's policy rate below the nominal GDP growth rate. Historically, the U.S. has adopted similar policies during the periods of 1991-94, 1996-2000, 2003-06, and 2010-19—these periods often coincided with the most exuberant bull markets in U.S. stocks. Figure: The macro environment of "Run It Hot" has historically fostered bull markets in U.S. stocks

Under specific conditions, this policy environment may push the bull market into bubble territory, as seen in 1996-2000. Key conditions include:

Major technological revolutions triggering investor optimism about the future;

Figure: Investor optimism about technological advancements sets the stage for potential asset bubbles

Household balance sheets being extremely optimistic, with declining savings rates driving an increase in risk appetite.

Figure: Strong household balance sheets provide ample ammunition for rising risk appetite

The bull market of 1991-94 did not evolve into a bubble because the internet revolution only accelerated after the launch of Netscape Navigator in late 1994. Similarly, the bull market bubble of 2003-06 was primarily concentrated in real estate, and after the internet bubble burst, investors remained cautious about the stock market. The bull market of 2010-19 also did not form a bubble, partly due to households focusing on deleveraging and rebuilding savings in the context of long-term economic stagnation.

Today, we believe that market conditions are trending towards creating a "Goldilocks" environment, similar to the late 1990s and 2020-21—periods that ultimately fostered stock market bubbles. The Trump administration is once again intent on running the economy hot, while the AI revolution continues to accelerate, American household balance sheets remain robust, and wealth appreciation may further amplify risk appetite.

In fact, the recent rapid rise in U.S. stocks and cryptocurrencies has preliminarily confirmed this bubble narrative. As the Federal Reserve capitulates in the coming months and the government maintains economic momentum, we believe there is significant room for bubble expansion.

In U.S. stocks, our preference remains for large-cap tech stocks. The structural AI investment cycle remains solid, with AI-related capital expenditures reaching a historic high as a percentage of GDP. We believe that if AI achieves another major breakthrough, it could push the valuations of large-cap tech stocks into deep bubble territory.

In crypto assets, our preference is for Ethereum. Over the past few years, Ethereum has significantly underperformed Bitcoin, even becoming one of the most shorted cryptocurrencies at one point. However, as Wall Street begins to replicate MicroStrategy's Bitcoin strategy in Ethereum, and the U.S. government promotes the legalization and expanded application of stablecoins—half of which are based on the Ethereum blockchain—the market narrative for Ethereum has rapidly reversed. With the ETH/BTC ratio breaking upward and global risk appetite warming, the long-awaited altcoin rally (led by Ethereum) seems to have finally arrived. Figure: Ethereum has been heavily shorted (left) Stablecoins driving narrative reversal (right) Figure: The ETH/BTC exchange rate is expected to rise further

In commodities, we continue to favor silver over gold during the bubble phase. The current silver-to-gold ratio is at a near 200-year historical low, laying the groundwork for a rebound similar to 2011. Additionally, during periods of rising risk appetite, silver has historically outperformed gold, as investors are more willing to move further along the risk curve. Figure: The silver-to-gold ratio is at a historical low (left) Silver outperforms gold during rising risk appetite phases (right)

Although risk assets typically perform well in a "Run It Hot" macro environment, the trends of the dollar and U.S. Treasuries are not clear. For example, the dollar appreciated from 1998 to 2000 but entered a bear market from 2003 to 2006; U.S. 10-year Treasury yields plummeted sharply from 1991 to 1993 but trended upward from 2003 to 2006. This indicates that beyond the "Run It Hot" backdrop, other key factors are shaping the future trends of the dollar and U.S. Treasuries.

Unlike in the past, there are three major differences in the current "Run It Hot" scenario: 1. The independence of the Federal Reserve is increasingly questioned due to President Trump's ongoing pressure on monetary policy; 2. The risk of inflation expectations becoming unanchored is rising, especially as rate cuts are pursued amid high prices and tightening labor supply; 3. The U.S. is pushing for global trade rebalancing through high tariffs and other aggressive measures, which not only reduces the inflow of global surpluses into U.S. capital markets but also undermines international confidence in U.S. capital markets. Figure: The U.S. is in a period of trade rebalancing (right) The risk of inflation expectations becoming unanchored is rising (left)

In summary, these factors suggest that while the Trump administration insists on running the economy hot, it may exacerbate investors' concerns about long-term inflation; meanwhile, Washington's adjustments in trade and security policies are prompting global investors to reassess their heavy exposure to U.S. markets, increasing demand for currency hedging, and significantly shifting funds toward non-U.S. assets. Figure: The dollar bear market has prompted a rotation of global funds toward non-U.S. assets

Therefore, we firmly believe that under the current "Run It Hot" framework, the dollar is more likely to weaken, while U.S. Treasury yields will face sustained upward pressure.

In the July monthly report, we had predicted a technical rebound in the dollar, driven by the unsustainable divergence in growth rates, interest rate differentials, and capital market performance between the U.S. and non-U.S. markets. Although the tactical long dollar strategy has yielded returns in recent weeks, the rebound has been significantly weaker than expected. In addition to renewed concerns about labor market turmoil, we believe that President Trump's ongoing criticism of the Federal Reserve has substantially limited the dollar's further upside potential. Given that Trump may appoint an extremely dovish "shadow" Federal Reserve chair in the coming weeks, and investor concerns about the labor market persist, we believe the dollar may have entered a consolidation phase.

The dollar's strength being hindered is clearly favorable for global risk assets, as it helps avoid a rapid tightening of global financial conditions. As a result, the performance of emerging market stocks is expected to continue. As we pointed out in our latest "China Macro Observation" report, the sharp appreciation of the dollar remains the single largest risk facing the Chinese stock market. Now, given that the dollar has failed to achieve a meaningful rebound, the recent adjustment in the Chinese stock market has instead provided an attractive buying opportunity. Figure: The structural weakening of the dollar provides a buying opportunity for the Chinese stock market