Macroeconomic Report: How Trump, the Fed, and Trade Triggered the Largest Market Fluctuation in History

Author: Capital Flows

Compiled by: Shenchao TechFlow

Macroeconomic Report: A Storm is Approaching

“What important truths do very few people agree with you on?”

This is a question I ask myself every day when studying the market.

I have models regarding growth, inflation, liquidity, market positions, and prices, but the ultimate core of macro analysis is the quality of creativity. Quantitative funds and emerging artificial intelligence tools are eliminating every statistical inefficiency in the market, compressing the advantages that once existed. What remains is the macro volatility that manifests over longer time periods.

truth

Let me share a truth that few people agree with:

I believe that in the next 12 months, we will see a significant increase in macro volatility, surpassing that of 2022, the COVID-19 pandemic, and possibly even exceeding the 2008 financial crisis.

But this time the source of the fluctuation will be the planned devaluation of the US dollar against major currencies. Most people believe that the decline of the dollar or “dollar devaluation” will drive up risk assets, but the reality is quite the opposite. I believe this is exactly the biggest risk in today's market.

In the past, most investors believed that mortgages were too safe to trigger systemic panic, while also overlooking that credit default swaps (CDS) were overly complex and irrelevant. Now, the complacency in the market regarding the potential depreciation of the dollar still exists. Few have delved into this depreciation mechanism, which could turn from a barometer into a real risk for asset prices. You can uncover this blind spot by discussing the issue with others. They insist that a weaker dollar always benefits risk assets and assume that the Federal Reserve will intervene whenever serious problems arise. It is this mindset that makes a deliberately designed depreciation of the dollar more likely to lead to a decline in risk assets rather than an increase.

The Road to the Future

In this article, I will elaborate on how this mechanism works, how to identify the signals when this risk manifests, and which assets will be most affected (including both positive and negative impacts).

All of this boils down to the intersection of three major factors, which are accelerating as we approach the year 2026:

The liquidity imbalance caused by global cross-border capital flows leads to systemic vulnerabilities;

The Trump administration's stance on currency, geopolitics, and trade;

The new Chairman of the Federal Reserve will align his monetary policy with Trump's negotiation strategy.

The root of imbalance

For many years, unbalanced cross-border capital flows have caused a structural liquidity imbalance. The key issue is not the scale of global debt, but how these capital flows shape balance sheets, making them fundamentally fragile. This dynamic is similar to the situation with adjustable-rate mortgages before the Global Financial Crisis (GFC). Once this imbalance begins to reverse, the structure of the system itself accelerates the correction, liquidity rapidly dries up, and the entire process becomes difficult to control. This is a mechanical fragility embedded in the system.

It all started with the United States as the world's only “buyer”. Due to the strong position of the dollar as a reserve currency, the U.S. can import goods at prices far below domestic production costs. Whenever the U.S. purchases goods from other parts of the world, it pays in dollars. In most cases, these dollars are reinvested by foreign holders back into U.S. assets to maintain trade relations, as the U.S. market is almost the only option. After all, where else can you bet on the AI revolution, robotics, or people like Elon Musk?

This cycle repeats endlessly: the U.S. purchases goods → pays dollars to foreign countries → foreign countries use these dollars to buy American assets → the U.S. can continue to purchase more cheap goods as foreign countries keep holding dollars and American assets.

This cycle has led to severe imbalances, with the United States' current account (the difference between imports and exports, shown by the white line) in an extreme state. On the other hand, foreign investment in U.S. assets (shown by the blue line) has also reached historic highs:

When foreign investors indiscriminately purchase American assets in order to continue exporting goods and services to the United States, this is precisely why we see the valuation of the S&P 500 index (price-to-sales ratio) reaching an all-time high.

The traditional stock valuation framework originates from the value investing philosophy advocated by Warren Buffett. This approach performs well during periods of limited global trade and lower liquidity within the system. However, what is often overlooked is that global trade itself expands liquidity. From the perspective of economic accounts, one end of the current account corresponds to the other end of the capital account.

In practice, when two countries engage in trade, their balance sheets will guarantee each other, and these cross-border capital flows exert a strong influence on asset prices.

For the United States, as the world's largest importer of goods, there has been a significant inflow of capital into the country. This is also why the ratio of the total market capitalization to GDP in the U.S. is significantly higher than in the 1980s—the era when Benjamin Graham and David Dodd established the framework for value investing in “Security Analysis.” This does not mean that valuation is not important; rather, from the perspective of total market capitalization, this change is more driven by changes in macro liquidity than by the so-called “Mr. Market's irrational behavior.”

One of the main sources driving the fragile capital structure of the mortgage market before the outbreak of the Global Financial Crisis (GFC) was foreign investors purchasing debt from the U.S. private sector.

Michael Burry's “The Big Short” that bet against the subprime mortgage crisis during the global financial crisis was based on insights into fragile capital structures, and liquidity is a key factor that is repriced with changes in domestic and cross-border capital flows. This is also why I believe there is a very interesting connection between Michael Burry's current analysis and the cross-border liquidity analysis I am conducting.

Foreign investors are injecting more and more capital into the United States, with both foreign capital inflows and passive investment inflows increasingly concentrated in the top seven stocks of the S&P 500 index.

It is important to note the type of imbalance here. Brad Setser provided an excellent analysis of this, explaining the dynamics of carry trades in cross-border capital flows and how they structurally trigger extreme complacency in the market:

Why is all of this so important? Because many financial models (which I believe are incorrect) assume that in the event of future financial instability—such as a sell-off in the US stock or credit markets—the dollar will rise. This assumption makes it easier for investors to continue holding unhedged dollar assets.

This logic can be simply summarized as follows: Yes, my fund currently has a very high weight in U.S. products, because the “dominance” of the U.S. in global stock indices is beyond doubt, but this risk is partly offset by the natural hedge provided by the dollar. This is because the dollar tends to rise when bad news arises. During major stock market adjustments (such as in 2008 or 2020, although the reasons are different), the dollar may strengthen, and hedging dollar risk essentially cancels out this natural hedge.

Conveniently, the expectation that the dollar serves as a hedge for the stock (or credit) market, based on past correlations, has also increased the current return rates. This provides a rationale for not hedging exposure to the U.S. market during times when hedging costs are high.

However, the problem is that past correlations may not persist.

If the rise of the US dollar in 2008 was not due to its status as a reserve currency, but rather because when carry trades are unwound, the funding currency usually appreciates (while the destination currency typically depreciates), then investors should not assume that the US dollar will continue to rise during future periods of instability.

One thing is for sure: the United States is currently the recipient of most arbitrage trades.

Foreign capital did not flow out of the United States during the global financial crisis.

This is the key reason why today's world is so different from the past: the returns for foreign investors on the S&P 500 depend not only on the index's returns but also on the returns of the currency. If the S&P 500 rises by 10% in a year, but the dollar depreciates against the investor's local currency by the same amount, this does not mean a positive return for foreign investors.

The following is a comparison chart of the S&P 500 Index (blue line) and the hedged S&P 500 Index. It can be seen that considering currency fluctuations significantly alters investment returns over the years. Now, imagine what would happen if these years of changes were compressed into a short time period. This enormous risk driven by cross-border capital flows could be magnified.

This leads us to a catalyst that is accelerating its arrival - it is putting global arbitrage trading at risk: the Trump administration's stance on currency, geopolitics, and trade.

Trump, Forex and Economic Warfare

At the beginning of this year, two very specific macro changes have emerged, accelerating the accumulation of potential risks in the global balance of payments system.

We observe that the depreciation of the dollar coincides with the decline of the US stock market, and this phenomenon is driven by tariff policies and cross-border capital flows, rather than domestic default issues. This stems from the kind of imbalance risk I mentioned earlier. The real problem is that if the dollar depreciates while the US stock market is declining, then any intervention by the Federal Reserve would further depress the dollar, which will almost inevitably amplify the downward pressure on the US stock market (contrary to the traditional view of the “Fed Put”).

When the source of the sell-off is external and currency-based, the Federal Reserve's situation will become more difficult. This phenomenon indicates that we have entered the “macro end game,” in which currency is becoming the asymmetric key pivot of everything.

Trump and Bessent are publicly advocating for a weaker dollar and using tariffs as leverage to gain the upper hand in the economic conflict with China. If you haven't yet followed my previous research on China and its economic war against the United States, you can watch my recorded YouTube video titled “The Geopolitical End Game.”

The core view is that China is deliberately undermining the industrial foundations of other countries, thereby creating dependence on China and generating leverage to achieve its broader strategic goals.

From the moment Trump took office (red arrow), the US dollar index (DXY) began to decline, and this was just the beginning.

It is noted that short-end real rates are one of the main factors driving the US Dollar Index (DXY), which means that monetary policy and Trump's tariff policy together become key driving factors of this trend.

Trump needs the Federal Reserve to adopt a more accommodative stance on monetary policy, not only to stimulate the economy but also to weaken the dollar. This is one of the reasons why he appointed Steven Miran to the Federal Reserve Board, as Miran has an in-depth understanding of the mechanisms of global trade.

What was the first thing Milan did after taking office? He placed his dot plot projections a full 100 basis points below the predictions of other Federal Open Market Committee (FOMC) members. This is a clear signal: he is extremely inclined towards a dovish stance and is trying to guide other members towards a more accommodative direction.

Core viewpoint:

There is a core dilemma here: the United States is in a real economic conflict with China and must respond actively, or it risks losing its strategic dominance. However, the weak dollar policy achieved through extremely loose monetary policy and aggressive trade negotiations is a double-edged sword. In the short term, it can boost domestic liquidity, but it also suppresses cross-border capital flow.

A weakened dollar may lead foreign investors to reduce their exposure to U.S. stocks as the dollar depreciates, as they need to adjust to new trade conditions and a changing foreign exchange environment. This places the U.S. on the edge of a cliff: one path is to confront China's economic aggression head-on, while the other path risks significant repricing of the U.S. stock market due to the dollar's depreciation against major currencies.

The new Federal Reserve Chairman, the midterm elections, and Trump's “great chess game”

We are witnessing the formation of a global imbalance that is directly related to cross-border capital flows and currency peg. Since Trump took office, this imbalance has accelerated, as he has begun to confront the biggest structural distortions in the system, including the economic conflict with China. These dynamics are not theoretical assumptions, but are already reshaping markets and global trade. All of this is setting the stage for next year's catalytic event: the new Federal Reserve Chairman will take office during the midterm elections, while Trump will enter the last two years of his term, determined to leave a significant mark in American history.

I believe that Trump will push the Federal Reserve to adopt the most aggressive dovish monetary policy to achieve the goal of a weak dollar, until inflation risks force a policy reversal. Most investors assume that a dovish Federal Reserve is always good for the stock market, but this assumption only holds when the economy is resilient. Once dovish policies trigger adjustments in cross-border capital positions, this logic will collapse.

If you have followed my research, you would know that long-term interest rates always price in the central bank's policy mistakes. When the Federal Reserve cuts rates too aggressively, long-term yields rise, and the yield curve experiences bear steepening to counteract the policy missteps. The current advantage for the Federal Reserve is that inflation expectations (see chart: 2-year inflation swap) have been declining for a month, which alters the risk balance and allows them to adopt a dovish stance in the short term without triggering significant inflationary pressures.

As inflation expectations decline, we have received news about the new Federal Reserve chairman, who will take office next year and may align more closely with Miran's position rather than the views of other Federal Reserve governors:

If the Federal Reserve adjusts the terminal rate (currently reflected in the eighth SOFR contract) to better align with changes in inflation expectations, this will begin to lower real interest rates and further weaken the dollar: (as inflation risks have just decreased, the Federal Reserve has room to do so).

We have seen that the recent rise in real interest rates (white line) has slowed the trend of the dollar (blue line) falling, but this is creating greater imbalances and paving the way for further rate cuts, which is likely to push the dollar lower.

If Trump wants to reverse the global trade imbalance and confront China in economic conflicts and artificial intelligence competition, he needs a significantly weaker dollar. Tariffs provide him with negotiating leverage to reach trade agreements that align with a weak dollar strategy while maintaining America's dominance.

The problem is that Trump and Bessent must find a balance among multiple challenges: avoiding politically destructive outcomes before the midterm elections, managing a Federal Reserve that has several less dovish positions internally, while hoping that a weak dollar strategy does not trigger foreign investors to sell U.S. stocks, thereby widening credit spreads and impacting the fragile labor market. This combination easily puts the economy on the brink of recession.

The biggest risk is that the current market valuation is at historically extreme levels, making the stock market more sensitive to changes in liquidity than ever before. This is why I believe we are approaching a significant turning point within the next 12 months. The potential catalytic factors that could trigger a stock market sell-off are rapidly increasing.

“What important truths do few people agree with you on?”

The market is entering a structurally risky environment with almost no price-setting in a near-dreamlike state: an artificially manipulated devaluation of the dollar, which will turn what investors see as tailwinds into a major source of volatility over the next year. The complacency surrounding a weak dollar resembles the complacency surrounding mortgages before 2008, which is why a deliberate devaluation of the dollar could have a greater impact on risk assets than investors expect.

I firmly believe that this is the most overlooked and misunderstood risk in the global market. I have been actively building models and strategies around this single tail event in order to short the market on a large scale when a structural collapse truly occurs.

Seize the timing of macro turning points

What I want to do now is to directly connect these ideas with specific signals that can reveal when certain risks are rising, especially when cross-border capital flows begin to change the structure of macro liquidity.

Positioning unwinds frequently occur in the U.S. stock market, but understanding the driving factors behind them determines the severity of selling pressure. If the adjustments are driven by cross-border capital flows, the market's vulnerability will be greater, and the level of alertness to risks needs to be significantly heightened.

The chart below shows the main time periods when cross-border capital positions began to exert greater selling pressure on the US stock market. Monitoring this will be crucial:

Note that since the market sell-off in March, the Euro to US Dollar (EURUSD) has rebounded and the bullish call skew has soared, the market has maintained a higher baseline level of bullish call skew. This elevated baseline is almost certainly related to potential structural position risks in cross-border capital flows.

Whenever cross-border capital flows become a source of liquidity expansion or contraction, this is directly related to the net flows through foreign exchange (FX). It is crucial to understand the specific positions of foreign investors' increases and decreases in the U.S. stock market, as this will serve as a signal for when risks begin to rise.

I recommend that everyone track this dynamic primarily through the factor models provided. The underlying performance of factors, industries, and themes is a key signal for understanding how capital flows operate within the system.

This is especially important for the topic of artificial intelligence (AI), as an increasing amount of capital is disproportionately concentrated in this area:

To further explain the connections of these fund flows, I will be publishing an interview with Jared Kubin for subscribers during the first week of December (you should follow him on Twitter: link). He is the founder of and a valuable resource in my learning journey.

The main signals of cross-border sell-offs include

The US dollar depreciates against major currencies, while the implied volatility across assets rises.

Observing the skew of major currency pairs will be the key confirmation signal.

You can monitor through the CVOL tool:

As the US dollar falls, the stock market also experiences sell-offs.

The downward pressure in the stock market may be led by high beta stocks or thematic sectors, while low-quality stocks will suffer greater impacts (which is also why you should pay attention to ).

Cross-asset and cross-border correlations may approach 1.

Even a small adjustment in the world's largest imbalances can lead to high correlation among assets. Observing the stock markets and factor performance of other countries will be crucial.

Final signal: The Federal Reserve's injection of liquidity has led to a further decline in the dollar and intensified selling pressure in the stock market.

If the depreciation of the dollar caused by policy leads to domestic stagflation pressure, this situation will be even more dangerous.

Refer to Brad Setser's article:

Despite a slight increase in gold and silver during the cross-border sell-off earlier this year, they still faced sell-offs during the real market crash due to their cross-collateralization with the entire system. While holding gold and silver may have upside potential, they do not provide diversified returns when the VIX (Volatility Index) truly spikes. The only way to profit is through active trading, holding hedge positions, shorting the dollar, and going long on volatility.

The biggest problem lies in the fact that we are currently in a phase of the economic cycle where the real return on holding cash is becoming increasingly low. This situation systematically forces capital to move forward along the risk curve in order to establish net long positions before the liquidity changes. Timing this transition is crucial, as the risk of not holding stocks during the credit cycle is as significant as the risk of not having hedges or holding cash during a bear market.

(I currently hold long positions in gold, silver, and stocks, as the liquidity driving factors still have upward potential.

I have detailed for paid subscribers:

The Macro End Game

The core message is simple: the global market is ignoring the single most important risk in this cycle. The deliberate devaluation of the dollar, combined with extreme cross-border imbalances and high valuations, is brewing a volatility event, reminiscent of the complacency we saw before 2008. While you cannot predict the future, you can correctly analyze the present. Current signals have already indicated that pressure is gradually building beneath the surface.

Understanding these mechanisms is crucial as they can tell you which signals to pay attention to, and these signals become more pronounced as risks approach. Awareness itself is an advantage. Most investors still assume that a weakening dollar will automatically benefit the market. This assumption is dangerous and incorrect today, just like the belief in 2007 that mortgages were “too safe.” This marks the silent beginning of the macro endgame, where global liquidity structures and monetary dynamics will become the decisive driving forces for every major asset class.

Currently, I remain bullish on stocks, gold, and silver. But a storm is brewing. When my models start to show a gradual increase in this risk, I will turn bearish on stocks and immediately inform my subscribers of this shift.

If 2008 taught us anything, it is that warning signals can always be found, as long as you know where to look. Monitor the right signals, understand the dynamics behind them, and when the tide turns, you will be ready.