It is rare that a Fed meeting is not the main event during the week of its occurrence. But, when competing with general elections—as it did this round—there is no contest. So, the Fed’s well-anticipated 25-basis point cut had little impact on markets.
The big moves had already occurred in response to Republicans retaking the White House and the Senate and looking likely to eke out a narrow majority in the House of Representatives. Stocks soared and bond yields jumped. It is clear that the second Trump administration will come into office with a very strong mandate given wide margins of victory in both the electoral college and the popular vote. This would suggest a determined pursuit of policy changes in a whole range of areas, with investors particularly focused on trade, immigration, and fiscal policy. Campaign proposals on all these fronts are, without a doubt, directionally inflationary. Tariffs, deportations, and further tax cuts at a time when the budget deficit is already projected to consistently exceed 5% of GDP even on current law, all speak to the same outcome: higher inflation.
What is still very unclear is the magnitude of the inflationary impulse since we do notyet know exactly what policies will be a) proposed and b) approved. Timing matters:early, “all-in” action would be more inflationary, gradual with exceptions, less so.
Moreover, the very same policies can have very different effects depending on themacro context in which they are implemented. Take immigration, for example. Therewas a time in 2022 when the number of job openings exceeded the number ofunemployed by over 6.0 million; as of September, this measure of labor market supply tightness had shrunk to just 0.5 million. Other measures such as average weekly hours and the quits rate suggest the labor market is less tight today that itwas just prior to Covid, a view that Chair Powell expressed as well in the press conference. Deportations equate to a negative labor supply shock. But when they occur in a backdrop of declining labor demand, the ensuing inflationary impact mayprove to be fairly contained. Furthermore, immigration is not only a labor marketfactor. Yes, it raises labor supply, but it also increases demand for a range of items, specifically housing. A positive demand shock here in the context of inelastic supply is inflationary, a negative one could bring some relief. In conclusion: forecasting the ultimate outcome of all these potential policies is a highly uncertain exercise.
When asked about how policies changes may impact the economy and Fed policy,Chair Powell said the following: “we do not guess, we do not speculate, we do notassume” how policies may change. The Fed waits for actual proposals, then models possible scenarios, and decides afterwards if a change of course is needed. Ofcourse, markets are by their very nature going to speculate and seek to gauge the impact of as-yet-uncertain policy shifts. A lot of that has already happened (this is not to say there isn’t more to go). But the economy does not behave that way. And so,we intentionally hold back from making any big changes to the forecast at this time. We do agree that the scope for 2025 Fed easing has narrowed, but we do not believe it to have closed. We still see a 25 bp-cut in December, and at least three more similarly sized cuts in 2025.
