The Fed has made it clear that they are highly attuned to the need for balance in delivering on their dual mandate
Coming into this week, investors were seeking greater clarity on both fiscal and monetary policy, looking to the U.S. electorate and the Federal Reserve to provide that transparency. Former President Donald J. Trump’s victory in the U.S. presidential election (winning the popular vote and carrying the electoral college) was compounded in its impact by the Republicans exceeding expectations on gains in the Senate and most likely the House as well. The speed of the outcome was also surprising, with the lack of uncertainty – which had been widely expected – catalyzing significant rallies in pockets of the equity markets and further increases in U.S. Treasury rates.
Against this backdrop, and consistent with their continued move to a more accommodative stance, the Fed lowered the fed funds target rate by 0.25% to a range of 4.50% to 4.75%. The decision was unanimous, despite whispers of an upcoming pause becoming increasingly louder. The accompanying statement reflected the commitment to the Fed’s dual mandate of delivering maximum employment and inflation at the rate of 2% over the longer run, but also acknowledged that inflation remains somewhat elevated despite the progress made.
Of note from the subsequent press conference, Fed Chairman Jerome Powell pushed back on a prescriptive set of data as it relates to the December rate decision. While he acknowledged that economic data was stronger than what was reflected in September’s Statement of Economic Projections, he pointed to upcoming labor and inflation data as being instrumental in determining if a pause is appropriate. He also opined that the recent “run-up in bond rates” was attributable to a higher likelihood of stronger growth, and perhaps more limited downside risks, rather than a reflection of higher inflation expectations. Powell was unwilling to provide predictions on or a response to potential policy changes under the new administration but was quite succinct in his assertion that he will remain in his role as Fed Chair until his term expires in May 2026.
In our mind, the probability of a pause comes back to the downward trend in inflation; we maintain our expectation that we will see further deceleration down to 2.7% core CPI year-over-year in the first half of 2025. But we note that inflation remains well above the Fed’s target, and we believe a pause in rate cuts seems increasingly likely in the future although not necessarily this year. Consensus is converging to this view by pricing a terminal rate of around 4% but it will not be achieved without some volatility which we expect will persist and extend to long end rates as investors seek clarity on the Fed’s ultimate path.
While Powell was clear that he would not opine on potential policy changes, we are focused on the scope of Trump 2.0— what are possible scenarios for the Republican-led government regarding tariffs, immigration, regulation, and taxes and what are the implications for economic growth, inflation, and the level of interest rates. Tariffs are undoubtedly inflationary, and, while we have little specificity around the eventual size and scale of his tariffs, our preliminary estimate for increases in inflation due to tariffs as stated by Trump’s campaign is around 0.1% to 0.25% year-over-year. Similarly, it is too early to know the details of the President Elect’s immigration policy and how it will impact reductions in labor force supply and demand dynamics. As a result, our view is that an inflationary uptick may not manifest until the second half of 2025 – perhaps coinciding with the end of the Fed’s cutting cycle.
Helping to drive equities higher over the last two days is Trump’s intent to prioritize deregulation and industrial re-shoring, which has potential to spur “animal spirits” among US corporations (including small businesses) and drive increases in capital spending. Trump also has conveyed his intent to reduce energy prices to achieve disinflationary growth while boosting consumer confidence. From a fiscal perspective, Trump and Republicans have indicated that further tax cuts will be enacted, though we note tax rate reductions are more likely to eliminate a headwind by extending the TJCA cuts that expire at the end of 2025, rather than helping to create a new tailwind. Similar to our estimate on inflation above, and noting far more details are necessary, our preliminary projections are that pro-growth initiatives by the Trump Administration could be a modest boost to GDP in 2025, with potentially larger effects in subsequent years.
In short, the Fed has made it clear that they are highly attuned to the need for balance in delivering on the dual mandate. The fiscal landscape is changing, and in many ways the Fed is merely a consumer of those changes and in the same camp as consumers and corporations. While we believe the path of rates remains firmly downward, aligned with inflation, we acknowledge that the next twelve months could bring meaningful shifts within the global economy, and monetary policy, while likely not the star of the show, will no doubt play an important part in the success of the production.
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