Beneath the Noise—A Risk Assessment of the Late-Cycle Landscape
“The element of surprise works like a charm. I always try to go into deals with an edge.”
“All warfare is based on deception. When able to attack, we must seem unable.”
President Donald Trump holds a chart as he delivers remarks on reciprocal tariffs during an event entitled "Make America Wealthy Again" at the White House in Washington, D.C. on April 2. Brendan Smialowski/AFP via Getty Images
The Return of the Tariff Shock—And the Illusion of Strategy
If history teaches us anything, it’s that markets respond not only to policy—but to the perception of chaos. Over the last six weeks, that chaos has returned in the form of sweeping trade policy, market volatility, and political theater. In early April, the Trump administration announced an extraordinary escalation in trade policy: a 10% blanket tariff on all foreign imports and sharply higher levies on strategic targets, with cumulative duties on Chinese goods reaching as high as 145%. It marked the most sweeping synchronized imposition of trade barriers since the 1930s.
Markets recoiled. The S&P 500 fell over 10% in a matter of days, swap spreads compressed violently, and the Global Financial Stress Index triggered its Critical Stress Signal—an event that, since 2013, has preceded major local bottoms but often surfaced near systemic fragility. Then, as suddenly as it appeared, the administration announced a 90-day pause, exempting smartphones, computers, and other consumer electronics. Markets stabilized. Headlines shifted. But the noise remained.
To many, this appears as erratic policymaking. But to those inside the administration, this is strategy. Treasury Secretary Scott Bessent, in a recent interview, laid out a comprehensive framework: the tariffs are not an end in themselves, but one leg of what he described as a “three-legged stool”—alongside tax reform and deregulation. Trade policy, in this telling, is not simply protectionism—it is leverage. Geopolitical leverage against China, economic leverage in Latin America, and negotiating leverage with strategic partners like Japan and South Korea.
Bessent’s remarks offer a glimpse into a broader vision: fast-cycle negotiations with allies, targeted financial backing of aligned governments, and tariff carve-outs designed to avoid collateral damage. IMF and World Bank support for Argentina, for example, is no longer seen as development aid—it’s seen as a counterweight to Beijing’s influence. In this sense, trade policy is part of a geoeconomic chessboard. And markets, understandably, are struggling to differentiate between opening gambit and final move.
But even if the strategy is deliberate, the consequences are real. Markets don’t price intent—they price impact. While the administration may frame tariffs as a long-term tool of economic architecture, the short-term effects remain inflationary, dislocating, and unpredictable. The cost of capital rises. Input prices climb. Margins compress. Capital investment decisions stall. Even with a pause in place, the ambient uncertainty has already begun to affect behavior in boardrooms and trading floors alike.
This, in turn, creates the illusion of calm—where the absence of immediate escalation is mistaken for stability. Yet underneath the surface, second-order effects are already in motion. Earnings guidance becomes more cautious. Supply chains, already reconfigured post-COVID, begin shifting again. Multinationals delay cross-border capex. And most crucially, the bond market begins to whisper what equities refuse to say out loud: the cumulative weight of these policies may be enough to tip the cycle.
The danger, then, is not just in the tariffs themselves—but in how they obscure what’s happening beneath the surface. When headlines scream trade war, investors often miss the subtler signals—slowing credit, faltering consumption, and the erosion of financial plumbing. Tariff shocks may be loud, but recessions rarely begin with fanfare. More often, they begin quietly—when the data looks muddled, the outlook feels uncertain, and the risks seem priced in… until they aren’t.
“In politics, stupidity is not a handicap”
What’s Overlooked: The Signals Beneath the Surface
The US LEI fell again in February and continues to point to headwinds ahead,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “Consumers’ expectations of future business conditions turned more pessimistic. That was the component that weighed down most heavily on the Index in February. Manufacturing new orders, which improved in January, retreated and were the second largest negative contributor to the Index’s monthly decline.
While much of the market's attention has fixated on the drama of tariffs and trade, a quieter, more consequential narrative is unfolding in the macroeconomic data. The kind of narrative that doesn’t trend on social media or get picked up by financial pundits—but that, historically, has told the truth long before markets caught on.
Start with the Leading Economic Index. Compiled by the Conference Board, the LEI is designed to forecast future economic activity based on a composite of forward-looking indicators—manufacturing orders, jobless claims, building permits, equity performance, consumer expectations, and yield spreads. It has now declined for 24 consecutive months, the longest contractionary stretch since its inception. In every modern cycle where the LEI has shown sustained deterioration of this magnitude, a recession has followed. There are no exceptions. Not one.
In contrast, the Coincident Economic Index (CEI)—which includes payrolls, income, and industrial production—continues to tick modestly higher. This divergence between LEI and CEI is perhaps the most underappreciated signal in today’s macro environment. Investors see current strength in the labor market and take it as a sign of resilience. But history tells us that the CEI always lags. In 2007, just months before the global financial crisis, payroll growth remained positive while leading indicators had already rolled over. In late 2000, the same pattern held: coincident indicators looked stable, even as the forward signals collapsed.
This time, the gap is even more pronounced. Some observers dismiss the LEI’s relevance, arguing the economy has changed, that manufacturing is a smaller share of GDP, that equity markets reflect services, not goods. But this misses the point. What matters is not that the economy looks different, but that the signals are deteriorating together. Consumer expectations are falling. Jobless claims are no longer improving. The yield curve has reversed from inverted to positive—a change that, paradoxically, is more concerning than the inversion itself.
Indeed, the yield curve is perhaps the clearest signal investors are underpricing. For much of 2023 and 2024, the 2-year and 10-year Treasury yields remained inverted, a widely acknowledged recessionary omen. But inversion is merely the warning light. It is the re-steepening—when the short end drops as the market prices in aggressive rate cuts—that usually coincides with the recession’s actual onset. That turn is now underway. The 10Y–3M spread, deeply inverted for over 18 months, is climbing back toward zero. In every case since 1970, this kind of movement has preceded a recession within 6 to 12 months.
To be clear, no single indicator is predictive on its own. But when the LEI, yield curves, and consumer forward-looking data all align with deteriorating credit conditions and falling global PMIs, the signal-to-noise ratio becomes too high to ignore. Yet it is being ignored—not because investors disbelieve the data, but because the surface-level economy still feels good enough. Payrolls remain positive. Retail spending, though weakening, hasn’t collapsed. Services inflation remains sticky. These are the echoes of late-cycle inertia, not signs of expansion.
The risk here isn’t just that recession is coming. The risk is that we're already in the glide path, and most participants are watching the wrong dashboard. When the data that always leads turns, and the data that always lags holds flat, the false sense of stability often sets the stage for sharper repricing.
And so we find ourselves at a familiar junction: one where markets are debating whether the storm has passed, just as the barometric pressure begins to fall.
“It is better to foresee even without certainty than not to foresee at all.”
The Quiet Cracks: Consumer and Credit at the Margins
If the leading indicators point toward economic deceleration, and the bond market confirms that shift, then the question becomes: where will it first break? Not on the front page—not in large-cap earnings or headline GDP prints—but at the edges, in places where credit becomes both more expensive and less available. That process, we believe, has already begun.
Start with the U.S. consumer. Beneath the resilience often cited—strong job growth, elevated savings rates, stable housing prices—there is a cohort that is already running out of road. Subprime credit card delinquencies have risen by over 7.4 percentage points since early 2022, peaking in late 2024, and plateauing at levels last seen during the early stages of the 2008 downturn. Auto loan defaults, too, are accelerating—not just among lower-income borrowers, but across the credit spectrum. This is not a broad collapse—it is a creep. One missed payment at a time. One borrower at a time.
But credit cycles do not unravel all at once. They fray quietly, in segments no one pays attention to until liquidity disappears. And when they finally snap, it is usually not because of the consumer—but because of the institutions that lend to them.
“The greatest shortcoming of the human race is our inability to understand the exponential function.”
Which brings us to private credit.
Over the past decade, the rise of private credit has been hailed as a structural innovation: more flexible than traditional lending, less regulated than banks, and capable of stepping in when others stepped out. That flexibility came with a price. In chasing yield, many private lenders have absorbed leverage risk and liquidity risk simultaneously. Today, the private credit market exceeds $1.6 trillion—larger than the entire U.S. junk bond market—and continues to grow.
But growth masks vulnerability. As interest rates remain elevated, refinancing windows narrow. Many borrowers who secured financing in 2021–2022 at floating rates are now facing debt service burdens up 30–40%. Secondary market activity in private credit—rarely noticed outside of industry circles—has surged. Investors are seeking exits. Fund managers are marking down portfolios in ways that suggest underlying distress. And yet, public markets remain blissfully unaware.
This is how fragility works. It doesn’t declare itself. It doesn’t trend. It builds in silence.
And there is a historical precedent for this silence. In the second half of 2007, the first visible signs of strain weren’t in the S&P 500 or in economic data. They were in asset-backed commercial paper and structured vehicles that suddenly couldn’t roll their funding. Similarly, today’s risk doesn’t lie in a single private credit fund—it lies in the ecosystem: business development companies (BDCs), non-bank lenders, mezzanine funds, and CLO warehouses, all navigating tighter liquidity in a higher-rate world.
If rates remain elevated, and economic momentum slows as expected, this complex could become a transmission mechanism. What begins as a repricing in private debt could bleed into broader risk assets—not because investors see the problem, but because the liquidity they relied on has evaporated.
The yield curve steepens. Leading indicators decline. And somewhere, beneath the surface, credit is tightening. Not in headlines. Not in earnings calls. But in real-time, across the system.
That is the nature of late-cycle fragility: it’s rarely dramatic—until it suddenly is.
“History never repeats itself, but it does often rhyme.”
Global Margin Calls: The Japan Carry Trade and the Quiet Leverage Beneath It
If the U.S. credit markets are quietly fraying at the edges, the global financial system may already be shifting beneath the surface—not loudly or obviously, but unmistakably. For decades, Japan’s exceptionally loose monetary policy—negative interest rates coupled with aggressive Yield Curve Control (YCC)—underpinned global market stability by providing nearly limitless, inexpensive yen funding. Investors across the globe borrowed yen at virtually zero rates to fund positions in U.S. equities, emerging market debt, private equity, and other risk-intensive assets, confident in Japan’s seemingly permanent accommodative stance. But simplicity masks fragility. The very ease and scale of this trade concealed immense structural leverage and profound vulnerability.
That vulnerability became explicit in early 2024. After seventeen years, the Bank of Japan shifted decisively away from ultra-easy policy, first ending negative rates in March and then raising its short-term interest rate to 0.25% in July—its sharpest tightening move in nearly two decades. Markets felt the shock instantly. Equities dropped sharply, bond yields swung violently, and global volatility surged as leveraged yen-funded positions unwound rapidly. That initial stress event, while brief, should have been a warning—not simply a momentary disruption, but the first visible fracture in the foundation of global risk-taking.
Today, in April 2025, the yen continues to appreciate, with USDJPY hovering around 142, far below its recent high above 150. This move is not merely a currency adjustment; it's evidence of ongoing structural repositioning. Institutional investors, particularly leveraged funds and asset managers, have moved aggressively into net long JPY positions, betting explicitly on further yen appreciation. Such positioning could suggest limited immediate upside in JPY absent new catalysts. Yet, this crowded positioning itself creates fragility—a market vulnerable to sharp reversals should geopolitical or monetary conditions shift unexpectedly.
Indeed, the evolving geopolitical backdrop further complicates the yen’s trajectory. Active trade negotiations between the U.S. and Japan have heightened uncertainty. While markets speculate about potential U.S.-Japan currency coordination, such direct policy alignment seems improbable given the severe consequences it would entail for Japan’s monetary independence. The Bank of Japan remains cautious and deeply committed to maintaining policy credibility. Policymakers have made clear their intent to keep monetary policy distinctly separate from diplomatic negotiations. Any forced alignment of monetary policy with geopolitical objectives would erode the BoJ’s credibility, risking severe market volatility and unintended financial tightening.
This delicate balance means the BoJ’s near-term policy path is less certain than markets might assume. If Japan’s economic outlook weakens—perhaps due to escalating tariffs, a global slowdown, or renewed geopolitical tensions—the BoJ could pivot back toward neutral or even consider policy easing, rather than delivering additional hikes. Thus, the immediate expectation of rapid yen appreciation driven solely by BoJ rate hikes may prove misguided.
Yet beneath these immediate market assumptions lies a deeper systemic vulnerability. Japan remains one of the largest holders of U.S. Treasuries, holding over $1 trillion in U.S. debt securities. Should negotiations or geopolitical pressures inadvertently lead Japan’s institutions to defensively liquidate these assets or repatriate substantial capital, global markets could face a profound liquidity shock. Even without aggressive BoJ tightening, forced yen strengthening through geopolitical pressure could rapidly transform a moderate unwinding into a full-blown systemic event.
We have witnessed similar scenarios historically. In 1998, LTCM’s spectacular collapse was triggered by rapid yen appreciation and a forced unwind of leveraged global arbitrage positions. In 2007, the yen’s swift strengthening exacerbated early stresses in global financial markets, magnifying the early signs of the global financial crisis. Even the liquidity panic of March 2020 saw yen volatility contributing significantly to global market stress. In each instance, yen appreciation—particularly when rapid and involuntary—served as an accelerant, amplifying underlying fragilities into outright crises.
Today, similar dynamics are at play—arguably with greater leverage, more complex global interdependencies, and heightened geopolitical stakes. The current yen carry trade unwind is not a simple currency fluctuation or market adjustment. It represents a deep structural repositioning, with implications that extend far beyond Japan’s borders.
The key distinction markets must grasp is this: The risk is not merely crowded positioning or near-term yen moves. It’s that geopolitical or policy missteps could involuntarily trigger disorderly yen appreciation, resulting in forced global asset liquidations, liquidity shocks, and rapid contagion across leveraged portfolios.
We are not simply observing a currency adjustment. We are navigating a potential systemic pivot point—a scenario quietly building beneath the noise of short-term market moves and headlines. This isn’t hypothetical. It is structural, historical, and ongoing.
The yen carry trade unwind demands our vigilance precisely because markets still largely misunderstand its true nature—mistaking quiet repositioning for calm, and complexity for stability.
The Bullish Wildcard: A Contrarian Path to Melt-Up
While our core framework emphasizes structural fragility, credit stress, and path-dependent volatility, we must humbly acknowledge an alternative scenario—one that, despite seeming improbable at first glance, could quickly gather momentum given the right policy and psychological triggers.
History consistently teaches investors that markets climb walls of worry precisely when sentiment seems most fragile and positioning appears overwhelmingly defensive. And indeed, sentiment today is negative enough, with bearish positioning sufficiently widespread, that even a modest shift in policy direction or tone could ignite a rapid and powerful repricing of risk assets.
Consider tariffs, the epicenter of recent market anxiety. President Trump's aggressive tariff escalation was intended, we believe, primarily as a negotiation tool rather than a permanent regime shift. The global economy’s current turbulence, caused largely by trade uncertainty, could quickly dissipate if Trump pivots to a softer stance—something he has shown a willingness to do repeatedly, including during the 2018–2019 trade tensions. Such a reversal, or even a temporary tariff truce, could significantly alleviate near-term inflation fears, reduce global growth risks, and restore confidence in forward earnings projections.
In parallel, a rapid deceleration in inflation—triggered by tariff easing and softer economic conditions—could swiftly shift Federal Reserve rhetoric from vigilant tightening to cautious accommodation. Contrary to the consensus belief in a “higher for longer” policy path, a mild recession or even slowing growth could compel the Fed toward early rate cuts or at least more accommodative signaling. Such a pivot would catch investors off-guard, especially those positioned defensively or short duration. Falling yields would not only ease corporate funding conditions but also re-ignite investor flows into growth-sensitive sectors—technology, consumer discretionary, and cyclical industries currently trading at depressed multiples.
This potential combination—policy reversal on trade, rapidly falling inflation expectations, and a dovish pivot by the Federal Reserve—could trigger an explosive rally that defies current economic skepticism. Valuation multiples could expand sharply as discount rates drop, and earnings, buoyed by stable demand and softer input costs, would stabilize or even surprise to the upside. Such a scenario could plausibly push the S&P 500 towards significantly higher levels, potentially breaking above 5800 to as high as 6000 by mid-to-late 2025.
Critically, this potential melt-up scenario doesn't hinge purely on fundamentals. Rather, it reflects a tactical repricing driven by sentiment reversal, positioning unwinds, short-covering dynamics, and momentum-driven flows—a classic “pain trade” for bearish investors. This type of market move is historically not uncommon, particularly in late-cycle phases when bearishness becomes consensus, and policymakers demonstrate more sensitivity to financial market stress than investors currently anticipate.
To be clear, our base case remains cautious, grounded in structural concerns over global liquidity fragility, embedded leverage, and long-term valuation pressure. But we must remain intellectually honest: markets can—and regularly do—behave irrationally, overshooting fundamental fair values and moving in ways that defy conventional logic. Ignoring the potential for a contrarian melt-up, especially given today's positioning and sentiment landscape, would be shortsighted and overly dogmatic.
Consequently, our analytical framework emphasizes deliberate humility and flexibility. Recognizing the plausible conditions that could trigger a sharp, sentiment-driven market rally, we've outlined targeted and limited-risk strategies that reflect the possibility of a bullish scenario emerging unexpectedly. Primarily through thoughtful options structures, such as call spreads and carefully designed volatility expressions, market participants can maintain exposure to potential upside scenarios while preserving prudent risk controls.
In essence, while our fundamental risk assessments strongly suggest caution, our role as analysts demands that we openly acknowledge—and help market participants thoughtfully consider—the conditions under which a powerful, if transient, market melt-up might unfold. Rather than presenting forecasts with misplaced certainty, we strive to illuminate multiple credible paths. By clearly mapping these divergent scenarios, we aim to equip investors and decision-makers with the analytical tools and nuanced insights needed to navigate an inherently uncertain and increasingly complex macroeconomic landscape.
“The essence of investment management is the management of risks, not the management of returns”
What If We’re Wrong? Acting with Clarity in a World That Isn’t
We’ve laid out a detailed, data-driven, and historically informed argument for why the current market environment carries more structural fragility than fundamental strength. Yet, if there's a single question that every investor must relentlessly ask—especially at a time as uncertain as this—it is not simply, "What do I believe?" It’s also, critically: "What if I'm wrong?"
It’s at moments like this that we should pause, step back, and borrow not the tone but rather the temperament of investors like Howard Marks. In his recent commentary, Marks reminds us wisely that uncertainty isn't merely an occasional feature of investing—it’s the defining condition. The real error investors make is rarely failing to precisely predict the future. Instead, it is assuming that precise prediction is possible at all.
Our base scenario—a market environment defined by tightening liquidity, structural cracks in credit markets, and geopolitical uncertainty—may very well capture the essential truth of our present conditions. Yet humility demands we consider the opposite: perhaps the economy reaccelerates unexpectedly. Perhaps inflation, stubborn today, retreats faster than anyone expects, allowing the Fed to engineer the much-hoped-for soft landing. Perhaps Trump's aggressive tariffs remain more optics than outcome, receding quietly into the background as trade frictions are smoothed. Perhaps consumer strength endures, earnings exceed tempered expectations, and global capital markets adjust seamlessly to higher-for-longer interest rates.
In such a world, the dramatic risks we've outlined would not materialize as sharply or as quickly as anticipated. But importantly, even then, our disciplined positioning would not leave us exposed—it would leave us poised. If fundamentals realign positively, quality assets would quickly and powerfully be rewarded. Businesses with strong cash flows, high-grade credits, real assets, and sectors positioned to benefit from lower discount rates and a re-stabilized growth outlook would rapidly regain investor favor. Under such conditions, the perceived "cost" of caution would quickly shift into a strategic advantage—a hedge against hubris, a reservoir of optionality.
Yet, if we are correct—even directionally—the payoff remains deeply asymmetric.
Today’s conditions echo, at least structurally, the defining characteristics of historical late-cycle environments: leveraged financial systems, increasingly restrictive liquidity conditions, geopolitical volatility, and widespread investor complacency toward embedded market risks. Whether manifested through subtle stresses in private credit, accumulating fragility in consumer balance sheets, pressure within the global funding markets, or complacency about policy effectiveness, these are not mere tail risks—they're deeply central risks that have yet to be fully accounted for in pricing.
Our analytical perspective does not seek to alarm, nor do we intend to predict outright catastrophe. Rather, we aim to illuminate these core fragilities clearly and objectively. The strategic frameworks, scenario analyses, and data-driven insights we provide are intended to help investors and decision-makers independently assess and interpret potential paths forward, adapting their own strategic thinking according to their specific needs, objectives, and constraints.
Markets rarely provide perfect clarity, particularly at critical junctures. This current moment is no exception. Yet, the absence of clarity should never be mistaken for an absence of analytical conviction or intellectual discipline. On the contrary, uncertainty itself is a powerful signal—one that demands nuanced thinking, rigorous challenge, and strategic flexibility. As an independent research firm, we embrace this uncertainty as our guide, committed to delivering analysis that not only withstands scrutiny but thrives precisely because it anticipates multiple possibilities.
In short, clarity is not found by predicting a singular future but by thoughtfully preparing for many. Our role is not to dictate the path ahead but to illuminate it—equipping investors with the analytical tools, context, and insights they need to navigate the inherently uncertain market landscape with informed clarity, disciplined flexibility, and strategic preparedness.
“It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change”
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