Confidence is contagious

Bottom Line

NFL Coaching legend Vince Lombardi once said “Confidence is contagious.” He followed it up with, “So is lack of confidence,” but the point is made, and applies well to the upbeat mood of many consumers and companies since the US election. And to investors, too. The S&P 500 has soared 19% from its August 5 low to 6,090 last week—its 57th record high of the year—as investors continue to process the ramifications of the “Red Wave.” Our full-year target for this year remains at 6,200, but we envision the enthusiasm to lead to 7,000 by year-end 2025. We base this in part on potential policies of the Trump administration that could improve economic growth, including a secure southern border, deregulation, lower tax rates and onshoring of manufacturing.

Feeling good Business and consumer confidence has surged in recent months, and a soaring wealth effect is positively impacting high-end consumption, offsetting weaker low-end demand. 

• The University of Michigan Consumer Sentiment Index soared from an eight-month low of 66.4 in July 2024 to an eight-month high of 74.0 in December.
• The Conference Board’s Consumer Confidence Index rose from a two-year low of 97.8 in June 2024 to a 16-month high of 111.7 in November.
• The NFIB Small Business Optimism Index rose from an 11-year low of 88.5 in March 2024 to a more than two-year high of 93.7 in October.

Trade takes center stage Naturally, there are cross currents with the implementation of new policies. For example, Trump has discussed imposing steep tariffs on many of our trading partners to create incremental demand for domestic producers. That could result in retaliatory tariffs, which could increase prices and inflation. In our view, however, Trump’s threats are largely a negotiating tactic. Many US companies appear to feel differently. Fearing the risk of tariffs, they have been importing significantly more goods. Imports soared to a record high of $353.8 billion in September 2024, driving the trade deficit up to a more than two-year high of $83.8 billion, rising nearly 19% since August’s $70.6 billion. Companies have been stockpiling inventories with these imports, which typically increases GDP growth. But they eventually must liquidate these bloated inventories, which would reduce growth. So, there’s policy risk and timing uncertainty. Further muddying the waters is the potential resumption January 15 of the East coast and Gulf of Mexico dockworkers strike, which impacts 60% of our imports.

Holiday shopping got off to a solid start Retail spending during Back-to-School (BTS) season was up by only 2.2% y/y from June through September 2024. That’s the weakest rate in 15 years, as stressed low-end consumers are saving more and spending less. But October retail sales, which open the critically important holiday season, rose a stronger-than-expected 2.9% y/y, and Thanksgiving weekend sales looked solid, particularly online. Given the wealth effect, due to surging real estate and stock prices, and the recent increase in consumer confidence, we believe that high-end consumers are driving the bus to what should be robust seasonal spending. These consumers punch above their weight, as the top 20% typically account for 40% of overall consumer spending.

Inflation metrics has been persistent

• Core PPI wholesale inflation has risen from 1.8% year-over-year (y/y) in December 2023 to 3.1% in October 2024. 
• Core CPI retail inflation has declined from 3.9% y/y in December 2023, but it has stalled at 3.2-3.3% over each of the past five months through October 2024. 
• Core PCE inflation (the Fed’s preferred measure) has declined from its peak of 5.6% in February 2022 but has stalled at 2.7-2.8% y/y in five of the past six months through October 2024. The Fed is targeting 2%. 

All of this creates some uncertainty as to the Federal Reserve’s pace of rate cuts. We will know more after its policy-setting meeting December 18, especially from Chair Powell’s press conference, and their quarterly Summary of Economic Projections (SEP). The Fed cut interest rates by a supersized half point on September 18 and by another quarter point on November 7, taking the upper band of the fed funds rate down to 4.75%. We here expect a quarter-point cut on December 18 and the SEP to indicate only three 25 basis-point cuts in 2025, taking the terminal fed funds rate down to perhaps 3.75% by the end of September 2025. 

Increasing our GDP forecasts The equity, fixed-income and liquidity investment professionals who comprise Federated Hermes’s macroeconomic policy committee met last Wednesday to discuss the fiscal policy impact of the incoming Trump administration, the resilient economy, persistent inflation and the likely trajectory of interest rate cuts. For background, the Commerce Department  reported that growth in the first, second and third quarters was 1.6%, 3.0% and 2.8%, respectively. 

• We raised our estimate for fourth quarter 2024 GDP growth from 2.0% to 2.3%. The Blue-Chip consensus increased its from 1.8% to 1.9% (within a range of 1.4% to 2.5%), and the Atlanta Fed’s GDPNow is at 3.2%, up from 2.3%.
• Our full-year 2024 growth projection is now 2.8%, up from 2.7%. The Blue-Chip consensus left its unchanged at 2.7% (within a very tight range of 2.7% to 2.8%).
• Inflation has been sticky, so we left unchanged our year-end 2024 forecast for core CPI at 3.1%. Blue Chip kept its at 2.9% (within a range of 2.8% to 3.0%). Likewise, our year-end 2024 estimate for core PCE is now 2.7%, from 2.6%. Blue Chip left its unchanged at 2.5% (within a tight range of 2.4% to 2.5%).
• We raised our estimate for first quarter 2025 GDP growth from 1.9% to 2.1%. Blue-Chip raised its from 1.7% to 1.8% (within a wide range of 1.3% to 2.4%).
• We increased our projection for second quarter 2025 growth from 2.0% to 2.1%, while the Blue-Chip consensus left its unchanged at 1.9% (within a range of 1.3% to 2.4%).
• We raised our estimate for third quarter 2025 growth from 1.9% to 2.1%. Blue-Chip consensus lowered its from 2.0% to 1.9% (within a range of 1.3% to 2.4%).
• We raised our forecast for fourth quarter 2025 growth from 2.0% to 2.2%. Blue Chip reduced its estimate from 2.1% to 2.0% (within a range of 1.5% to 2.5%).
• Our full-year 2025 growth estimate is up from 2.1% to 2.3%. Blue Chip consensus raised its from 2.0% to 2.1% (within a range of 1.7% to 2.4%). 
• We left our year-end 2025 forecast for core CPI at 2.7%. Blue Chip raised its from 2.2% to 2.3% (within a range of 2.0% to 2.6%). We increased our year-end 2025 estimate for core PCE from 2.3% to 2.4%. Blue-Chip consensus left its unchanged at 2.1% (within a range of 1.9% to 2.4%).
• Our estimate for full-year 2026 GDP growth is 2.5%.