WEEK ENDING 11/8/2024
- We have a new president—well, maybe not new—along with a “red wave”
- Week-to-week changes hide volatility
- Oh, and the Fed cut the Fed Funds range by 0.25%
A CITY DIFFERENT TAKE
The uncertainty of who will be the new president has now vanished from the market’s collective wall of worry, disappearing in what only can only be called “butt-kicking” fashion. President-elect Trump won 312 electoral votes to Vice President Harris’s 226. On the popular vote front (as of this writing), it was Trump with 74,800,000 votes to Harris’s 71,200,000. Yes, a “butt-kicking” by both measures.
Oh, then the Fed reduced the Federal Funds target range by 0.25%. When asked if he would submit his resignation to Trump if requested, Chair Powell replied, “No.” When pushed further, he replied, “Not permitted under the law.”
The Associated Press recently published an article outlining the 12 major Trump policies. We will use this as a framework for a discussion of our views of their impact on the economy and interest rates.
- Immigration: Trump vowed to not just crack down on illegal migration but curtail immigration overall. Lower levels of legal immigration and attempts at mass deportation would reduce the supply of available workers, creating economic problems.
Our Financial Insight: Lower levels of immigration and mass deportations would create labor shortages, forcing employers to inflate wages to attract and retain employees. - Abortion: Trump played down abortion as a second-term priority, even as he took credit for the Supreme Court ending a woman’s federal right to terminate a pregnancy and returning abortion regulation to state governments.
Our Financial Insight: No econcomic impact that we can estimate. - Taxes: Trump’s tax policies broadly tilt toward corporations and wealthier Americans, leading to larger deficits. According to the non-partisan Congressional Budget Office, extending Trump tax cuts would add $4.6 trillion to the deficit.
“Some additional tax cuts seem probable in our view, although the timing, size and specifics are highly uncertain,” Wells Fargo economists Jay Bryson and Michael Pugliese wrote in a research note, adding that additional cuts could lead to somewhat faster economic growth in 2026 and 2027. Eco Impact of Trump Tax Cuts.
Our Financial Insight: Larger deficits lead to higher interest rates because the market demands a higher risk premium. - Tariffs and Trade: Trump’s posture on international trade is to distrust world markets as harmful to American interests. He proposes tariffs of 10% to 20% on foreign goods — and in some speeches has mentioned even higher percentages.
“A tariff is a tax paid by U.S. consumers, including businesses that use imports, such as steel, to make other products. The higher costs cause people and businesses to pay more for goods and encourage other countries to raise tariffs, making U.S. products less competitive in foreign markets. Tariffs also make the economy and companies less efficient by shielding domestic producers from competition.” Eco Impact of Policy
Our Financial Insight: This is inflationary. (Look to our “Week in Washington” section for a brief refresher on Smoot-Hawley.) In terms of credit impact, we think there will be dispersion within sectors that are adversely affected by tariffs. - DEI, LGBTQ, and Civil Rights: Trump has called for rolling back societal emphasis on diversity and legal protections for LGBTQ citizens.
Our Financial Insight: No economic impact that we can estimate. - Regulation, Federal Bureaucracy, and Presidential Power: The president-elect seeks to reduce the role of federal bureaucrats and regulations across economic sectors.
Our Financial Insight: Lowers regulatory costs, fostering a pro-growth environment. - Education: The federal Department of Education would be targeted for elimination in a second Trump administration.
Our Financial Insight: In the short-term, perhaps helps reduce the budget deficit. Long term, likely a negative economic impact. - Social Security, Medicare, and Medicaid: Trump insists he would protect Social Security and Medicare, popular programs geared toward older Americans and among the biggest pieces of the federal spending pie each year.
There are questions about how his proposal not to tax tip and overtime wages might affect Social Security and Medicare. If such plans eventually involved only income taxes, the entitlement programs would not be affected. But exempting those wages from payroll taxes would reduce the funding stream for Social Security and Medicare outlays.
Our Financial Insight: Larger deficits will drive higher interest rates as risk premium market will demand an increase. - Affordable Care Act and Health Care: Since 2015, Trump has called for repealing the Affordable Care Act and its subsidized health insurance marketplaces.
Our Financial Insight: We have a concept of an opinion. It is not good for those who need it. It is probably correlated to the segment of the population most impacted by inflation. - Climate and Energy: Trump, who claims falsely that climate change is a “hoax,” blasts Biden-era spending on cleaner energy designed to reduce U.S. reliance on fossil fuels.
Our Financial Insight: Hard to see “drill baby drill” as a good policy given current oil prices. - Workers’ Rights: Trump and Vice President-elect JD Vance framed their ticket as favoring America’s workers. But Trump could make it harder for workers to unionize.
Our Financial Insight: Lower wages also lower inflationary pressures, but generally are not good for economic growth. - National Defense and America’s Role in the World: Trump’s rhetoric and policy approach to world affairs are more isolationist diplomatically, non-interventionist militarily, and protectionist economically than the U.S. has been since World War II.
Our Financial Insight: This is ultimately inflationary. Becoming more protectionist economically decreases our sway in world markets.
In summary, we believe:
- These policies are good for short-term growth spurts. Stock markets seem to confirm this view.
- These policies will lead to higher deficits.
- These policies will lead to some kind of trade war.
- These policies will ultimately lead to higher inflation.
- Fixed-income investors can expect higher interest rates and a steeper yield curve (bear steepener) as the markets demand higher term structure risk premiums.
We will not violate the first rule of forecasting: forecast direction or forecast timing, but never in the same forecast.
It has been a volatile week in all markets. The following table reflects the daily changes in the markets from Wednesday through Friday:
We have seen the initial impact of the election on longer-term markets, but what about the short-term markets? What are the short-term market expectations for future Fed rate cuts? The following table reflects the markets’ implied probability of future Fed action on the day before the election (November 4) and at the end of the week (November 8).
The fixed-income markets anticipate smaller cuts in the Fed Funds rate target range with less confidence.
CHANGES IN RATES
What appears to be a relatively quiet week-over-week change in the Treasury market covers a lot of volatility. As highlighted above, all markets had considerable moves.
The municipal rates moved in the same pattern as Treasury yield and with the same volatility.
Municipals, as measured as a ratio versus their Treasury equivalent maturities, moved lower on the week.
Corporate yields were lower week over week.
THIS WEEK IN WASHINGTON
One of the largest drivers of near-term inflationary pressures is future tariffs. It seems the president does not need congressional approval to impose tariffs.
“‘For more than 80 years, Congress has delegated extensive tariff-setting authority to the president,’ the Congressional Research Service, a nonpartisan group made up of congressional staff, wrote in a February report.” Tariff Approval
We decided to contrast and compare the president-elect’s tariff views with one of the more infamous tariff policies in history, the Smoot-Hawley Tariff Act. Since Chris did most of his research in high school and college with books and encyclopedias, we will use Britannica.com as one of the research sources.
Smoot-Hawley Tariff:
“U.S. legislation (June 17, 1930) that raised import duties to protect American businesses and farmers, adding considerable strain to the international economic climate of the Great Depression. The act takes its name from its chief sponsors, Senator Reed Smoot of Utah, chairman of the Senate Finance Committee, and Representative Willis Hawley of Oregon, chairman of the House Ways and Means Committee. It was the last legislation under which the U.S. Congress set actual tariff rates.”
Impacts of Smoot-Hawley:
“Smoot-Hawley contributed to the early loss of confidence on Wall Street and signaled U.S. isolationism. By raising the average tariff by some 20 percent, it also prompted retaliation from foreign governments, and many overseas banks began to fail. (Because the legislation set both specific and ad valorem tariff rates [i.e., rates based on the value of the product], determining the precise percentage increase in tariff levels is difficult and a subject of debate among economists.) Within two years some two dozen countries adopted similar “beggar-thy-neighbour” duties, making worse an already beleaguered world economy and reducing global trade. U.S. imports from and exports to Europe fell by some two-thirds between 1929 and 1932, while overall global trade declined by similar levels in the four years that the legislation was in effect.”
What do the Trump tariff policies mean for the American consumer and economy?
“It’s bad for consumers,” said Mark Zandi, chief economist at Moody’s. “It’s a tax on consumers in the form of higher prices for imported goods.” “It’s inflationary,” he added. He and other economists predict the proposed tariffs would also lead to job loss and slower economic growth, on a net basis.
Mark Twain warned us that history does not repeat, but it does rhyme. Time will tell what the ultimate impact on the economy will be.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of November 18 at 2.27%, 2 basis points lower than the close of November 1. The 10-year Breakeven Inflation Rate finished the week at 2.35%, 2 basis points lower than the previous week’s close.
MUNICIPAL CREDIT
As of November 8, 10-year quality spreads (AAA vs. BBB) were 0.95%, 3 basis points tighter than the November 1 reading (based on our calculations). The long-term average is 1.70%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.68%, 11 basis points lower than the week prior. High-yield quality spreads were 16 basis points lower at 2.50%.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Overall, money market funds saw increased inflows compared to the week prior.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were mixed on the week. Significant among these were outflow in municipal.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced increased positive flows.
SUPPLY OF NEW ISSUE MUNICIPAL BONDS
The supply of new issues is expected to be about $5 billion this week. Supply has slowed down, which should support relative municipal bond returns.
CONCLUSION
With the election behind us, we can look forward to the possible outcomes of the new administration’s policies. We believe they will be supportive of the equity markets, at least in the near term. Deficits and government debt should increase as it finances all these growth incentives. If the growth incentives work out, we believe the Fed will be more reticent to decrease short-term rates because inflation should also increase. This should lead to a “bear steepener” event in which all rates increase (or at least stop declining), and long-term rates will be higher than short-term rates. This will steepen the yield curve.
Our neutral duration, overweighting the short end of the relative strategy’s investment universe within an actively managed adder structure, should prove effective in this environment. That said, it is a good time to remind our readers that our crystal ball gets fuzzy when forecasting long-term events. Much like the Fed, we will react to new data as it arrives.
IMPORTANT DISCLOSURES
The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks or estimates presented herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice.
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