Investment Newsletter – May 2025
Markets began May with strong momentum, driven by solid US economic data, including better-than-expected payrolls and services activity and a surprise 90-day tariff reduction deal between the US and China, which boosted investor sentiment. The S&P 500 saw its best day of the month following the tariff cut and softer- than-expected CPI data, reinforcing hopes of a soft landing. However, mid-month gains faded as fiscal concerns took centre stage after Moody’s downgraded the US credit rating and deficits remained elevated. Additional volatility arose from escalating tariff threats, legal challenges to the administration’s authority to impose them, and ongoing uncertainty over the fate of expiring tax cuts, all of which weighed on long-end bonds and risk assets toward month-end.
Elon Musk criticizes the Big Beautiful Bill as fiscally irresponsible, arguing that its structure of front loading tax cuts while delaying spending reductions until after 2029 will significantly deepen long term deficits, impose fiscal burdens on future administrations, and create economic drag that could undermine both financial stability and innovation, particularly as global risks escalate. In contrast, Trump praises the bill as a pro growth achievement that delivers immediate tax relief to individuals and businesses, claiming that it actually helps reduce the deficit compared to alternative spending heavy plans, and shifts blame to the Federal Reserve for not lowering interest rates, which he argues would allow the government to refinance its predominantly short term debt more affordably. All this unfolds in a deeply polarized environment where even product like Tesla carry political weight, amid rising global instability, technological disruption, and the growing urgency for America to generate enough economic growth to escape its escalating debt trap.
If President Trump proceeds with plans to remove Fannie Mae and Freddie Mac from conservatorship, both mortgage backed securities yields and mortgage rates are likely to rise further, driven by two key factors tied to White House policy. The first is the increased perception of credit risk, as the transition from government control to full public ownership, even with an implied guarantee, would likely lead markets to demand a higher risk premium on mortgage backed securities. The second and more complex issue relates to the demand for volatility hedges linked to mortgage backed securities prepayment risk, which has historically been met by Taiwan’s life insurance industry through its role in the issuance of Formosa bonds. These bonds provide a key source of long dated rate volatility that mortgage backed securities holders use to manage negative convexity. However, if Taiwan’s current account surplus shrinks due to changes in trade policy or currency appreciation, the supply of such hedges may decline, reducing the market’s ability to absorb volatility and potentially causing fixed income volatility to rise. This would further widen mortgage backed securities spreads and push mortgage rates higher . With the housing market already showing early signs of weakness, the added strain from higher rates and reduced financial insulation could increase the risk of a broader economic slowdown.
According to Goldman’s Japan trading desk, the recent bond buyer strike was driven by a lack of demand from life insurers due to negative duration gaps and regulatory changes, growing fiscal concerns ahead of the Upper House election that could raise fears of a JGB downgrade, and asset-intensive reinsurance activity that leads to JGB selling as reinsurers replace them with higher-yielding assets, all of which have severely weakened the supply and demand balance for long-dated Japanese government bonds.
