"Front-Loaded Max Pain": Wall Street Icon Reveals What's Needed For Trump's Plan To Work

Some interesting and truly unorthodox perspectives, excerpted from the latest report from iconic Wall Street strategist Dominic Konstam (currently head of macro at Mizuho, previously at DB) who lays out a provocative scenario: for Trump's economic transition - whether by means of stagnation or stagflationary shock - to work out, it requires front-loaded max pain (full pdf available to pro subs in the usual place).

Necessities of Trump’s economic transition imply either a festering stagnation or a stagflation shock with the latter increasingly likely: bad for risk assets; bad for the dollar and more curve steepening.

Let’s start on an optimistic note: Trump’s economic transition might work in the sense that the structural trade and budget deficits might improve and be consistent with a generational extension of the US’s global economic and political power. On a more salutary note, the economic transition should be far from easy as it requires at least a temporary loss of economic activity via heightened inflation risk. Politically, Trump will blame previous Administrations. The risk he runs is that it backfires so that, by the 2026 mid-terms, the would-be transition is short-circuited. The emphasis is and should therefore be, from Trump’s perspective, front-loaded max pain.

Since “liberation day” US Treasuries have dramatically diverged in their performance versus global peers, especially Europe, for good reasons. Despite tariff uncertainty, the ex ante effective tariff rate is still very likely to be draconian, in excess of 20 percent. If tariffs are not absorbed by corporates, the economy is likely to be hit by a stagflationary shock. If corporates do absorb the tariffs a prolonged period of disinflationary stagnation might be expected. Risk assets are quite rightly in disarray at either prospect.

The Fed would prefer stagnation rather than stagflationary shock as inflation would be lower and there is less chance of a sharp spike higher in unemployment.

Ironically unlike a classic economic downturn, the Fed doesn’t have a pre-emptive policy role in the current circumstances – despite what Trump thinks. If policy became “overly accommodative” a stagflationary outcome is more likely as corporates have less inclination to absorb tariffs. The associated risk of higher inflation expectations exacerbates the stagflation risk. A more restrictive policy stance, by contrast, puts the burden on corporates to absorb tariffs consistent with less inflationary pressure albeit against a likely slow stagnation in growth (subject to future stimulus).

Trump’s would-be Powell-ouster serves to make stagflation more likely than stagnation. It is more negative for risk assets and consistent with curve steepening from both ends. At some point long rates will be anchored as short rates fall but the trade off is less good under a stagflation implying the curve can be very steep - 2s10s closer to 200 bps.

If it wasn’t for fears of Fed bullying, the stagflation vs stagnation outcome is finely balanced. We show the potential hit to profits is significant but in principle corporates can absorb the most egregious tariffs so far threatened, albeit taking margins back closer to GFC type levels. The risk is that because of the very way in which profit margins exploded since Covid, corporates individually have less incentive to “absorb” therefore making a stagflationary shock a more likely outcome anyway.

Stagflation isn’t going to reduce the interest service on the debt unless the Treasury rolls debt into short maturities. There are other efforts to make Treasuries less “cheap” in terms of SLR reform but in the grand scheme of things this isn’t worth much, maybe a marginal 5-15 bps across tenors.

Concerns for Treasury “liquidity” also appear to be more of a red herring. The bottom line is there are very good reasons why foreign investors should be less attracted to US assets in general and risk premia naturally need to reprice.

Much more in the full note available to pro subs. Also make sure to read Konstam's previous note "Trump Needs A Recession To Succeed"