December 2024
As we start the new year, the consensus is that investors face a most uncertain future. That statement would raise the ire of most writing professors because the future is always uncertain. We can plan for an expected outcome, but the certainty of that outcome, no matter how high a probability we place on it, is never a certainty. Nevertheless, as we start the new year, the forecast for what lies ahead for the economy and the capital markets has never been cloudier.
The driving theme through the end of 2024, had been the Federal Reserve’s success in mostly putting the inflation genie back in the bottle and the expectation that they would rapidly normalize interest rates through a series of overnight rate cuts. The expectation, propagated by the Fed, was that they would bring the Fed Funds rate back to the 3% area. Equity investors were delighted by the prospect and stock prices rallied.
Donald Trump’s unexpected Presidential victory added further fuel to the equity rally as investors anticipated a wave of regulatory rollback that would fall to the bottom line of U.S. corporations. The unexpected frothiness of the market was undone on December 18th as the Open Market Committee presented a new set of Summary of Economic Projection’s (SEP) that showed the rate cuts expected in 2025 were less than that forecasted just three months earlier. Compounding that concern were the comments of the various committee members who collectively were saying that the cuts could be even slower than the SEP’s projected.
The reaction to the news has been swift with Fed Fund futures forecasting only a 70% chance of two 25 basis point rate cuts in 2025. Moreover, the change in language has resulted in a steep rise in yield-to-maturity across the yield curve. Specifically, since touching a low of 3.40% last September, the yield of on the 5-year note has risen by over 100 basis points to 4.59%. Similarly, the 30-year bond has risen nearly 100 basis points and is currently trading at just under 5%.
While the flip-flopping of the Federal Reserve has created much uncertainty in the markets, President-Elect Trump has only served to further cloud the crystal ball. He is not yet occupying the White House, but his pronouncements change daily. His threat of raising tariff’s on virtually all U.S. trading partners should be taken seriously but the unintended consequences of those tariffs is not entirely clear. Classically, tariffs are tantamount to an added tax on consumers, which should have no bearing inflation. But the rise in prices will show up in inflation measures which the Fed will need to consider when trying to again fight inflation. The risk is a cost-push situation in which consumers are squeezed by higher prices and demand higher wages to keep up with the rising cost of living.
Another uncertainty is financial services regulation. Bank’s rallied when Trump was victorious in November because the assumption was that their cost of operating within regulatory constrains would fall. That’s great for investors holding bank shares if banks operate responsibly, which given their operating history of the last twenty years is in no way assured.
Given the set of concerns we see, we are certain that the economic future is highly uncertain.
