I really, really would not want to be in charge of monetary policy right now. Yikes. In the best of circumstances they have a difficult job, and right now is far from the best of circumstances.

To understand the current challenges that policymakers face, you first have to rewind the clock to 1979. That was the year Paul Volcker was appointed as chairman of the Federal Reserve, and handed the unpleasant task of dealing with double-digit inflation. And deal with it he did – he jacked short-term interest rates to as high as 20%. That broke inflation, but it also broke the economy. Unemployment shot up into double digits in the depths of the subsequent recession. But Volcker held firm and by the time he took his boot off of the neck of inflation, it had fallen from over 14% to under 3%.

This triggered an incredible age of prosperity. In a world of fiat currency, none was more reliable than the US dollar, which was backed by central bankers willing to do the hard things to prevent inflation from debasing it. The strength of the US dollar (among other reasons) made it cheaper for Americans to buy goods from overseas, and foreigners were happy to have their wealth accrue in the US dollars they got from selling those goods, which they then plowed into US financial assets. This went on for a few decades, with an associated improvement in quality of life for a huge swath of the global population.

As always though, there can be too much of a good thing. The disinflationary force of increasing global trade and globalization meant that the Fed was seemingly free to overly focus on pro-growth monetary policy, since inflation (as they measured it) was non-existent. No one had to ask them twice to print trillions of dollars. Meanwhile, a functionally infinite foreign demand for USD bonds (i.e., to lend the US government money) meant that there were no checks on fiscal policy, and easy fiscal policy was popular and a good way for politicians to achieve their primary goal – to get re-elected. Corporations, focused primarily on juicing their own earnings, offshored more and more of their supply chains and manufacturing capabilities to cut costs.

We will never get to see the alternate universe where this unsustainable set of conditions ended organically, because Trump was elected and has made it his mission to blow up the status quo. As I write this in May of 2025, this is the state of the world:

1) The US no longer possesses the basic manufacturing capabilities required for self-sufficiency.

2) Foreigners have accrued ~30 trillion in USD securities over the last 40 years, and are now extremely overweight the US by any reasonable measure. We are now seeing the first signs that they want to reduce exposure, or at least stop growing it (which is almost as bad).

3) Loose US fiscal policy requires massive ongoing borrowing, meaning that we need foreigners to add to that already dangerous degree of USD concentration in their portfolios or we need to print USD and buy the bonds ourselves.

4) The US stock market is pricing in an implausibly rosy scenario. Whether or not it is a “bubble” is semantics, but at a minimum it is about as overpriced as it has been in its entire history.

This state of affairs presents policymakers – specifically the Fed – with an impossible job. There are no solutions, only trade-offs, and how they make those trade-offs will shape all of global economic activity for the foreseeable future. Here is their situation, as we see it:

Trade-off 1: The tension between growth and inflation

Tariff policies plus general antagonism towards our trade partners has created a mechanical rise in prices at the same time that it has contributed to weakening growth. Textbooks will tell you that the inflationary impact of tariffs should be transitory, but the textbooks have a mixed track record on inflation and it is scary to ease into inflation that is above your target. If the Fed eases aggressively to support growth, it is bullish stocks and gold, and bearish the USD. If they ease less than is priced – or tighten – the market action is more likely to be the opposite.

Trade-off 2: The tension between interest rates, exchange rates, and domestic economic conditions

As a general rule, central banks can manage two out of the three. For example, if your currency is weakening and you want to manage it, you can raise interest rates to attract capital inflows to support the currency. In that way you can control interest rates and the currency, but then your domestic economy has to endure tighter monetary policy. Alternatively, a central bank can choose to set interest rates to manage the domestic economy, and let the currency get set by market forces outside of their control. The Fed will have to decide how much dollar weakness they are willing to tolerate – and the associated inflation that comes with it – before they engage. This tension is made so much worse by 1) fiscal and trade policy that is dollar bearish 2) the understandably growing disinterest of foreigners in continuing to support the USD with financial asset purchases.

Trade-off 3: The tension between fiscal policy, growth, and interest rates

At the current run rate, the US Government spends about 2 trillion more per year than it takes in. To spend more than they make, they have to borrow the difference. If they stop spending so much, all of that spending will be removed from the economy and cause a downward shock to growth and equities. If they keep doing what they are doing, they need to significantly increase the supply of bonds, which means they are pressuring interest rates higher. Higher interest rates flow back into everything – asset prices, growth, and exchange rates. Or, the Fed can print money and buy the bonds themselves, which would let the tension squirt out via the currency weakening and inflation worsening instead of via interest rates rising.

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Large imbalances require a very large repricing of assets to resolve. Which assets – and in which direction – is more or less impossible to know since it will depend on the actions of policy makers who themselves do not know what they will do. What we do know is that markets have only priced in a small probability of these macro dynamics playing out, and only in pockets. Markets are instead pricing in that almost nothing Trump, Bessent, and team are doing will matter much and we should expect a continuation of the status quo. This creates the ingredients for low cost trades with very high potential payouts. Or put more simply - large swaths of options across equities, rates, fx, and commodities look cheap.