In a busy election week, one could almost be excused for forgetting about the Fed. At the November meeting, the U.S. Federal Reserve Open Market Committee voted to cut the Fed funds rate by another -0.25% to a new range of 4.50-4.75%. There were no dissents this time.
The formal statement noted that labor conditions “have generally eased” (compared to “slowed” in Sept.), and inflation has continued to make progress, although “further progress” was removed. Also removed was the comment about “greater confidence” in inflation moving toward 2%, reiterating that employment and inflation goals were roughly in balance. This continues to fall in line with the Fed’s shifting focus from inflation fighting to supporting full employment equally.
After the partial-surprise of September’s -0.50% rate cut, CME Fed funds futures initially pointed to continued dovish policy to end the year, with possibly even more half-percent cuts. But folks were getting carried away, especially closer to the election as some structural inflation concerns re-ignited. In recent days, odds settled in showing single quarter-percent cuts each for November and December (with a Dec. cut no longer a slam dunk, at only 2/3 odds) resulting in a total of -1.00% for the year, with Fed funds ending at 4.25-4.50%. The highest odds for June 2025 and December 2025 now both lie at 3.75-4.00%. The latter is a more recent change, and alludes to a front-loaded 2025, albeit a year with now a wider range of possible outcomes, and rates stabilizing a bit above the ‘neutral rate’ (the hypothetical place where policy is neither stimulative nor restrictive, but still contains a positive real yield) that is assumed to lie within the wide zone of 2.50-3.50%. That implies the Fed either stops and holds, or this becomes a slower, drawn-out cycle. While the Fed no doubt looks at a variety of scenarios internally, near-term actions are based on near-term reality, hence the cuts.
Economy. U.S. GDP growth for the 3rd quarter came in at 2.8%, better than some had expected during the quarter, and still above the ~2% long-term trend. For the 4th quarter, the Atlanta Fed’s GDPNow tool currently estimates 2.5%, which includes continued strength in personal consumption, as well as contributions from government and non-residential fixed investment. While manufacturing activity remains in long-standing contraction, it hasn’t worsened, with some contributions from high-tech spending related to the CHIPS Act, IRA, and artificial intelligence build-out. Services, the far larger component, continues to expand at a healthy rate with the added tailwind of wage growth normalizing lower after pandemic labor distortions. Further potential stimulus in the new administration over the next few years could also provide another possible backstop to the economy, which lowers recession odds further.
Inflation. On a trailing 12-month basis ending in September, headline CPI rose 2.4%, held down by weaker oil prices, while core CPI ex-food and energy was up 3.3%. In a later release, PCE inflation for the Sept. trailing year rose 2.1% at a headline level and 2.7% for core. The latter has been steady for about five months now, still above the Fed’s 2.0% policy target, yet at an improved 2.3% on an annualized basis over the past three months. Shelter costs and some remaining seasonal effects lie behind the stall in further core inflation improvement. Rental data shows up at a sizable lag in official government statistics, but it has fallen back in several real-time measures that should ultimately show up in CPI and PCE. The high inflation regime that peaked in 2022 has generally been written off by markets and policymakers as being over, although monetary policy that ultimately becomes ‘too’ easy runs the risk of re-igniting some price pressures, not to mention new post-election fiscal deficit math.
Employment. Labor conditions have been slowing/normalizing at a measured pace, in data such as falling job openings, until October’s disappointing nonfarm payrolls report, which featured uniquely negative hurricane and labor strike effects offset by some government job growth. The unemployment rate held steady at 4.1%, only having moved by a few tenths in either direction this year. Other than the recent weather/strike events, jobless claims remain contained, showing a lack of layoff activity. As has been studied by economists extensively, this cycle has behaved differently in that labor supply has risen sharply from immigration, helping ease some pockets of excess labor demand, but also skewing the statistics relative to normal. This weakening from peak employment conditions has given the Fed a credible reason to ease, in their view.
Some observers were baffled by the September -0.50% rate cut, since such dramatic moves are usually reserved for economic distress. Rather, it now appears the Fed was likely ‘making up’ for a missed July rate cut opportunity that it seemed to regret not moving ahead with. Nevertheless, the economic, inflation, and labor pictures don’t look problematic as a whole and still point to a ‘soft landing’ narrative. This includes the Fed loosening for ‘normalization’ reasons, backing off a tightness in policy no longer needed to fight the inflation no longer considered a problem. Economic strength (but also some fears over new inflation sources) has caused the number of assumed cuts in 2025 to be pared back a bit.
Rising long-term U.S. Treasury yields in recent weeks appear to have been somewhat election-driven, with a correlation between rising odds of a Republican presidency and a higher 10-year rate (by +0.75%). While neither party alleviated concerns over the federal government’s predicted annual budget deficit or burgeoning debt load, draft Republican plans seemed poised to widen the deficit further, with stable spending coupled with a drop in revenue. Ongoing deficit and debt concerns add to market worries about long-term sustainability and higher interest expense, let alone higher chances of inflation coming back, adding a ‘credit spread’ of sorts to the yield level. Though, demand for Treasuries remains strong globally, ironically perhaps made even more attractive by this extra yield premium.
Will the election outcome affect monetary policy? Some shifts take time, but upcoming policies could generate pressures in both directions. Higher deficits leading to inflation worries could result in rates staying higher than previously assumed. On the other side, tariff policy that comes on too strong could slow global economic growth, leading to weaker labor markets as well. So, these might be considered offsetting so far, with perhaps a slight nod to the risk of higher base inflation keeping rates more elevated than they might otherwise be.
From an investment standpoint, most importantly, most asset classes have historically fared well during periods of interest rate cuts. Easing removes the headwind of a tight policy constraint, encouraging a more normal financing environment, as well as improving the math for asset pricing in discounted cash flow valuation models. If all continues to move along as it has recently, there is no reason to believe in a deviation from that optimistic historical precedent. The exceptions, of course, are recessions, which have inserted a temporary speed bump into asset performance historically. But, the good news is that current recession odds remain low, especially with new political tailwinds, and the financial excesses that have tended to exacerbate deeper, structural recessions do not appear to currently exist.
Ryan M. Long, CFA
Director of Investments
FocusPoint Solutions, Inc.
Sources: CME Group, Federal Reserve Bank, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, FocusPoint Solutions calculations.
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Sources: Ryan M. Long, CFA; Director of Investments; FocusPoint Solutions, Inc.
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