New sheriff in town New sheriff in town http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\white-house-winter-small.jpg January 20 2025 January 21 2025

New sheriff in town

Peak policy uncertainty.
Published January 21 2025
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Bottom Line 

In the run-up to President Trump’s second term, investors have been trying to handicap the potential impact of his fiscal policies on inflation, economic growth, corporate profits, the Federal Reserve and financial-market performance. Equity enthusiasm prevailed from early August into early December, as the S&P 500 soared 19% over that four-month period to its 57th record high of the year at 6,090. But bond vigilantes held a dour view of the policy pendulum shift from “Bidenomics” to “Trumponomics,” as benchmark 10-year Treasury yields surged from 3.6% in mid-September to 4.80% last week. 

In many ways, uncertainty surrounding Trump’s fiscal policies could be a Rorschach test for investors. Stocks corrected by some 5% from early December to last week, but stocks and bonds got back in sync last week, with Treasury yields falling to 4.6% and the S&P rebounding 4%. Frankly, the market’s strength heading into the three-day holiday weekend and Monday’s inauguration surprised us, given the peak policy uncertainty gripping Trump’s return to the White House.

Trump trepidation The new president set an ambitious fiscal policy agenda for his first 100 days. The top of his to-do list is fixing immigration, which likely includes securing the southern border, deporting convicted criminals and increasing legal immigration. Critics worry that wage inflation could soar if gainfully employed foreign workers are caught up in the president’s deportation net. Increased tariffs are next. He wants to raise additional revenue, encourage onshoring and extract more favorable terms from our trade partners. Opponents contend this could spark retaliatory tariffs and trade wars, which could also elevate inflation.

Given the possible imposition of higher tariffs, many companies in the U.S. have been importing more goods than usual over the past several months before prices rise. The worsening trade balance should lower GDP, but has temporarily boosted inventories, which should goose GDP until companies begin to sell off their stockpiles. 

Trump has promised to cut regulations to spur stronger economic growth. Encouraging more energy exploration and production could create greater self-sufficiency, reduce inflation through lower energy prices, increase economic growth through higher exports and engineer a global peace dividend by reducing energy revenues to Russia and Iran. 

Finally, the creation of the Department of Government Efficiency (DOGE), chaired by Elon Musk, could be like other presidents’ efforts to streamline the federal government, such as Carter’s zero-based budgeting, Reagan’s Greenspan Commission, Clinton’s National Performance Review and Obama’s Simpson/Bowles Commission.

Business and consumer confidence have surged in recent months, reflecting enthusiasm in the election results: 

  • NFIB Small Business Optimism Index rose from an 11-year low of 88.5 in March 2024 to a six-year high of 105.1 in December 
  • 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
  • Conference Board’s Consumer Confidence Index rose from a nearly two-year low of 97.5 in April 2024 to a 16-month high of 112.8 in November

But recent inflation metrics have been persistent, with concerns Trump’s tariff and immigration policies may exacerbate the trend: 

  • Core PPI wholesale inflation has re-accelerated, nearly doubling from 1.8% year-over-year (y/y) growth in December 2023 to 3.5% in December 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 seven months through December 2024 
  • Core PCE inflation (the Fed’s preferred measure) declined from its peak of 5.6% in February 2022, but it has stalled at 2.7-2.8% y/y over the past seven months through November 2024. The Fed is targeting 2%. 

Holiday spending solid The labor market rebounded strongly in November and December from summer weakness that was likely due to the twin hurricanes and two since-settled strikes. In conjunction with a soaring wealth effect, holiday shopping has been running above industry forecasts, driven positively by high-end consumption, which offset weaker low-end demand. The National Retail Federation was projecting Christmas sales growth of 2.5-3.5%. Retail spending during Back-to-School (BTS) season was up only 2.2% y/y from June through September 2024, the weakest rate in 15 years. But retail sales at the start of the critically important Christmas season from October through December rose a stronger-than-expected 3.8% y/y, versus a weak 2.7% in 2023. 

Slower pace of Fed easing All of this creates some uncertainty as to the Fed’s number of rate cuts. We expect two quarter-point reductions this year, likely in June and September. That would lower the fed funds target range to 3.75-4%.

Raising our GDP forecasts The liquidity, equity and fixed-income investment professionals who comprise Federated Hermes’ macroeconomic policy committee met last Wednesday to discuss the Trump administration’s fiscal plans and the Fed’s likely response. The Commerce Dept. revised third quarter 2024 GDP growth up from 2.8% to a final gain of 3.1%, slightly higher than the 3.0% of the second quarter.

  • Fourth quarter 2024 GDP growth will be flashed on January 30. We raised our estimate from 2.3% to 2.5%; The Blue-Chip consensus raised its estimate from 1.9% to 2.3% (within a range of 1.8% to 2.6%); The Atlanta Fed’s GDPNow reduced its estimate from 3.4% to 2.7%.
  • We did not change our full-year 2024 growth estimate at 2.8%. The Blue-Chip consensus also left its at 2.7% (2.6% to 2.9%).
  • We raised our estimate for first quarter 2025 growth from 2.1% to 2.4%, while the Blue-Chip consensus increased its from 1.8% to 2.1% (1.6% to 2.6%).
  • We increased our forecast for second quarter 2025 growth from 2.1% to 2.4%, while the Blue-Chip consensus left its at 1.9% (1.5% to 2.4%).
  • We raised our estimate for third quarter 2025 growth from 2.1% to 2.4%, while the Blue-Chip left its at 1.9% (1.3% to 2.5%).
  • We raised our forecast for fourth quarter 2025 growth from 2.2% to 2.5%, while the Blue-Chip consensus reduced its from 2.0% to 1.9% (1.3% to 2.5%).
  • Consequently, we raised our full-year 2025 growth estimate from 2.3% to 2.5%, while the Blue-Chip consensus increased its from 2.1% to 2.2% (2.0% to 2.5%). 
  • We left our year-end 2025 forecast for core CPI inflation at 2.7%, while the Blue Chip raised its from 2.3% to 2.5% (2.3% to 2.9%). We also left our year-end 2025 estimate for core PCE inflation at 2.4%, while the Blue-Chip consensus raised its from 2.1% to 2.3% (2.1% to 2.7%).
  • Based upon our expectation for the full-year economic impact of Trump’s fiscal policy initiatives in 2025, we raised our estimate for full-year 2026 GDP growth from 2.3% to 2.9%, while the Blue Chip announced its at 2.0% (1.5% to 2.4%). 
  • We established our year-end 2026 estimate for core CPI inflation at 2.5%, while the Blue Chip announced  its forecast at 2.6% (2.2% to 3.2%). We established our year-end 2026 estimate for core PCE inflation at 2.3%, while the Blue Chip announced its at 2.4% (2.1% to 2.9%). 

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Tags Markets/Economy . Politics . Equity .
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DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The Conference Board's Consumer Confidence Index measures how optimistic or pessimistic consumers are about the economy.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

The Personal Consumption Expenditure Index: A measure of consumer inflation at the retail level that takes into account changes in consumption patterns due to price changes.

Producer Price Index (PPI): A measure of inflation at the wholesale level.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

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