In a week of silly and contradictory headlines, the Federal Reserve takes the top spot. The world’s premiere central bank managed to lower the fed funds rate into increasing inflation while reducing future rate hike expectations. Every month, they appear more political. After a month of reporting on weak consumer sales in high-priced discretionary items, retail sales come in above expectations. It would be good news except most of the increase was due to inflation. China is seeing declining bond yields as they try to stimulate a weak economy. Tesla $TSLA stock is up while the government is probably cutting EV subsidies. Is the market crazy, or does this actually make sense? Intern Alex joins us to explain the Dollar Milkshake Theory. You might have heard of it, but now you can understand it.

This week, we’ll address the following topics:

• The Federal Reserve cuts rates and increases its inflation projections?!
• Despite a shift away from discretionary goods, retail sales come in high – but most of that increase is due to inflation.
• China’s economy isn’t doing great. Their bond yields are down by a lot.
• Tesla $TSLA stock is up huge at the same time the government is considering cuts to EV subsidies.
• Is the Dollar Milkshake Theory delicious? No. Don’t worry, we explain.

Ready for a week of contradictory Fed policy? Let’s dive in:

1) The Fed Cuts Again and Increases Inflation Projections:

The Federal Reserve just completed its final meeting of the year and as expected, cut the fed funds rate by 25bp (.25%) to 4.25% – 4.50%. This was the last cut of the year with a total of 100bp (1%) of rate reductions in 2024. The press release commented on elevated inflation, expanding economic activity, and an uncertain employment situation. The Fed thinks they’ve achieved a balance in trying to reduce inflation and maintain high employment. (I think inflation is too high and the only reason the employment situation isn’t a disaster is due to government hiring.) It’s notable that Beth Hammack voted against the 25bp rate cut. This is unusual because most Fed votes are unanimous. There is a lot of attention right now on the dot plot where each Fed Governor makes predictions on where the fed funds rate will be in the coming years. The 2025 estimate rose from 3.4% in the September dot plot to 3.9%. That implies expectations for 50bp of cuts in 2025 down from 100bp of expected cuts. The 2026 estimate rose from 2.9% to 3.4%. That implies expectations for a total of 100bp of cuts (2025 plus 2026) down from 150bp of expected cuts. When you hear people talking about a “hawkish cut”, this is what that looks like. They cut, but reduced expectations for future rate cuts.

That’s a meaningful shift up for 2025.

DKI Takeaway: My view is the Fed has already cut too soon and as long as Congress continues engaging in stimulus spending, they should hold the fed funds rate firm. Every inflation metric started rising right after the September rate cut so I would have preferred to see them pause. In addition to a more hawkish dot plot, the Fed increased its inflation expectations indicating it expects to make NO progress reducing inflation in 2025. When the market started to realize the Fed is signaling a slower pace of rate cuts it traded down significantly. The DKI portfolio is well-positioned for more coming inflation so no changes here are necessary right now.

2) Retail Sales:

On Monday, we received the latest retail sales release ahead of Wednesday’s 25 bps Federal Reserve rate cut. The report came in strong, up 0.7% from the prior month and 3.8% year-over-year. Additionally, October’s sales data was revised upward from 0.4% to 0.5%. Motor vehicle sales and parts dealers were big contirbutors to the hot number. These figures indicate a surprisingly strong consumer, contrasting with the retail earnings reports we have covered over the past few weeks.

The Fed is cutting into higher inflation AND higher spending.

DKI Takeaway: Car sales are a key indicator strongly correlated with the health and growth of the economy. The Federal Reserve just cut interest rates in an economy that remains overstimulated by Congress, has increasing inflation, and growing consumer spending. While the past few weeks have reflected weak consumer earnings at specific retailers, there may be signs of a potential rebound. Notably, November often serves as an early indicator of holiday shopping trends, and although most forecasts suggest a weak holiday season, actual results could surprise to the upside. Overall, this retail sales release digs the Fed deeper into its growing hole.

3) China: A Snapshot of Contradictions:

China’s economic narrative is increasingly defined by its striking contradictions. On the one hand, it remains a key driver of global growth; on the other, it faces mounting structural challenges that threaten its financial stability. Yields on Chinese 10-year and 30-year government bonds have hit all-time lows, reflecting a significant shift in market sentiment. In response, the People’s Bank of China (PBOC) has tightened its grip, warning institutions against reckless trading while calling for more robust risk management. This comes as ultra-long bonds become a haven for investors amidst a broader slowdown, raising concerns about the sustainability of China’s growth model.

https://www.tradingview.com/symbols/TVC-CN10Y/

DKI Takeaway: The term “Japanification” has begun to surface as analysts draw parallels with Japan’s long-term deflationary spiral. Kyle Bass has pointed out that China’s banks are insolvent, with leverage soaring to 350% of “reported” GDP, the banking system showing signs of strain. Add to this a $39 billion surge in foreign exchange outflows presented itself in November, and speculation about a yuan devaluation grows louder.

4) Why Tesla $TSLA Soaring:

This past week, Tesla ($TSLA) soared to all-time highs, primarily driven by President Trump’s victory and the anticipated cuts to EV subsidies. However, the question arises: why is Tesla’s stock rallying if EV subsidies are soon to be eliminated? The reasons are somewhat counterintuitive at first, requiring you to look at the big picture. Overall, it’s clear that Tesla is the top EV manufacturer in the U.S. in terms of innovation, manufacturing, and consumer acceptance, not to mention their massive charging infrastructure. These factors collectively provide the basis for Tesla’s recent growth.

Elon Musk is again the world’s richest man.

The payment drops from $704/month to $479/month if you get the subsidy.

DKI Takeaway: When you’re the most dominant player in an industry, you no longer need subsidies to grow your sales and bottom line. That’s exactly why Tesla’s $TSLA stock is surging—especially when we consider rivals like Ford, Rivian, and General Motors. All these companies’ EV segments are unprofitable and heavily rely on consumer stimulus to encourage buyers. While Tesla’s dominance wasn’t achieved overnight, the company did benefit from the same government programs as its peers, including subsidies like the $7,500 EV tax credit. However, Tesla was consciously ahead of the curve, entering the EV market early and capitalizing on the initial hype. Those benefits have now paid off, allowing Tesla to support the elimination of the subsidies that aided their dominance. These cuts both strengthen their competitive moats and allow them to undercut their rivals.

5) Revisiting the Dollar Milkshake Theory: Why a Soaring Dollar Matters:

With the Dollar Index (DXY) hitting 108 last week, it’s an opportune moment to explain Brent Johnson’s Dollar Milkshake Theory. This framework offers a unique lens to understand global markets and highlights how a sovereign debt default may unfold. Critics often harp on the U.S. government’s $36 trillion debt mountain, but many other countries are no better off fiscally. What sets the U.S. apart is the Eurodollar market, a product of financial innovations by Midland Bank in the 1950s. Simply put, a Eurodollar is a dollar held or loaned outside the U.S.—think Germany lending to Japan in dollars. This market created an enormous external demand for dollars. Here’s where it gets dicey: in an environment of rising interest rates and a strengthening dollar, borrowers overseas face a double whammy. Not only do they pay higher interest, but they also grapple with currency risk. Unlike the U.S., these countries can’t print dollars to service their debts.

It’s ok – go ahead and ask.

DKI Takeaway: When dollar-denominated debt becomes unpayable, defaults follow. Defaults trigger credit contractions, which ironically drive the dollar even higher. The milkshake metaphor? It’s the dollar “sucking up” liquidity from weaker currencies, exacerbating the cycle. As the dollar continues to rise, the Milkshake Theory serves as a reminder of the global financial system’s deep interconnections—and the U.S. dollar’s dominant role within it.

 

Here’s the video version: https://youtu.be/yY3d18ecDjM

 

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