by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning. The market is digesting the latest GDP data. In sports, Real Madrid secured its fifth trophy of the year by winning the FIFA Intercontinental Cup. In today’s Comment, we’ll analyze the Federal Reserve’s latest rate decision, explore why long-term bond yields continue to rise, and review the Bank of Japan’s choice to maintain its monetary policy stance. As always, the report includes a roundup of key international and domestic data releases.

Fed’s Hawkish Cut: The Federal Open Market Committee voted to cut rates but also scaled back the number of projected rate cuts for 2025.

• In a widely anticipated decision, the Federal Reserve lowered its target range for the federal funds rate to 4.25%–4.50%. While most policymakers endorsed the move, Cleveland Fed President Beth Hammack dissented, advocating for no change. Alongside the rate cut, the Fed revised its economic projections, raising its 2025 inflation forecast from 2.1% to 2.5% and reducing its expected rate cuts from 100 to 50 basis points. During the press conference, Fed Chair Jerome Powell cautioned that the outlook for rate cuts could shift if inflation moderates further next year.
• The Federal Reserve’s ability to lower interest rates in 2025 will depend on inflation trends during the first quarter. In the first three months of 2024, monthly inflation peaked, driven by sharp increases in financial services, insurance, and housing costs. While the preceding months have moderated, the spike complicated the Fed’s efforts to meet its target inflation rate. The latest Personal Consumption Expenditure (PCE) price index indicates that while headline inflation was 2.3% year-over-year, underlying price pressures, excluding the surge from the first quarter, have moderated to an annualized rate of 1.9%.

• The Federal Reserve’s future policy rate decisions will hinge on inflation trends in the first quarter. If inflation moderates during this period, the Fed may adopt a more accommodative stance. Conversely, if inflation accelerates, a more restrictive policy may be necessary. This is because reducing inflation becomes more challenging after the first quarter, as spring and summer inflation trends have aligned with historical norms over the last two years. Consequently, we advise investors to remain cautious, as interest rates could move in either direction depending on how inflation unfolds.

Bond Market Roars: The 10-year Treasury yield has surged amid growing deficit worries and the Fed’s less accommodative policy stance.

• On Wednesday, the 10-year Treasury yield climbed to 4.5%, a level not seen since May. This rise was primarily driven by growing uncertainty about the Federal Reserve’s potential to cut interest rates in 2025. Since the Fed’s rate cut in September, Treasury yields have increased by nearly 90 basis points as investors became increasingly concerned that a widening budget deficit could exacerbate inflationary pressures. The Congressional Budget Office’s recent upward revisions to its forecasts for inflation, unemployment, and long-term interest rates have further fueled these concerns.
• Uncertainty surrounding next year’s policy direction, particularly the potential inflationary impact of tariffs and tax cuts, may be driving up bond yields. A recent study underscores the inflationary risks associated with these policies, estimating that a 10% tariff increase could raise the PCE price index by 0.6%, a 60% tariff on Chinese goods could add 0.4%, and a combination of both could increase it by 1%. Additionally, the proposed tax cuts, which are expected to boost aggregate demand, could further exacerbate inflationary pressures.

• Long-term Treasury yields are likely to be highly sensitive to fiscal policy changes in the year ahead. If the Trump administration proposes sufficient spending cuts or scales back some campaign promises, the bond market is likely to respond favorably. Moreover, tariffs, which are likely to face legal challenges, could prove less inflationary than currently anticipated. While we recognize the potential for upside risk in Treasury yields, we remain cautiously optimistic that market fears may not fully materialize.

The BOJ Holds: Japanese central bankers opted to maintain the current monetary policy stance, indicating a strategic pause before potentially implementing a third interest rate hike.

• The Bank of Japan (BoJ) held its benchmark interest rate steady at 0.25%, aligning with market expectations. However, one policymaker dissented, advocating for a rate hike to 0.5%. While policymakers expressed concerns about potential wage pressures, the decision to maintain the current rate likely reflects worries about the potential economic impact of US tariffs. During the press conference, BoJ Governor Kazuo Ueda hinted at the possibility of a future rate hike, possibly in January or March, when the central bank has a clearer understanding of wage pressures.
• Japanese policymakers’ persistent adherence to accommodative monetary policy has exacerbated concerns about their ability to effectively control inflation. This sentiment was reflected in the yen’s (JPY) depreciation following the central bank’s decision, surpassing the key 155 JPY level against the dollar. While overall inflation appears to be moderating, core inflation, excluding volatile energy prices, remains above the 2% target, signaling persistent price pressures. Notably, service sector inflation has accelerated, indicating that businesses are increasingly capable of passing on rising labor costs to consumers.

• The Bank of Japan’s decision to maintain low interest rates underscores the potential for countries to employ accommodative monetary policy to mitigate the potential negative impact of tariffs. By keeping their currencies relatively weak, these countries aim to maintain export competitiveness. However, this approach may lead to higher inflation within their own economies. As tariff tensions escalate, the dollar is likely to strengthen due to increased demand for a safe-haven currency. Furthermore, a lack of progress in global inflation could boost the appeal of commodities as investments.

In Other News: Russian President Vladimir Putin has expressed an openness to meeting with Donald Trump, a discussion that could potentially pave the way for resolving the conflict in Ukraine. Meanwhile, the US government is facing an increased risk of a shutdown as Elon Musk and Trump oppose a continuing resolution to prevent it.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is closely watching for the Federal Reserve’s latest rate decision. In sports, Real Madrid’s Vinícius Júnior has been awarded FIFA’s The Best player, a moment many see as restoring balance to the football world. In today’s Comment, we’ll preview the Fed’s decision, analyze the Dow Jones’ recent slump, and provide an update on Brazil. As always, we’ll conclude with a roundup of key domestic and international data releases.

Fed Decision: While the Fed is expected to cut rates today, markets will focus on the accompanying economic projections.

• The latest CME Group FedWatch Tool indicates a near-certainty of a 25 basis point rate cut today, with a 95% probability priced in. This confidence stems from reassurances from Fed officials and signs that the economic risks have become more balanced between inflation and unemployment. Earlier this month, Fed Governor Christopher Waller and Atlanta Fed President Raphael Bostic both signaled openness to a rate cut. Additionally, the November CPI inflation report, while up year-over-year, largely aligned with market expectations. At the same time, the unemployment rate has risen back to its 2024 peak level.
• While the rate cut at this meeting is widely anticipated, the market will be closely watching the number of rate cuts projected for 2025 in the updated dot plot. The September dot plot indicated that Fed officials expected to cut the federal funds rate target by a total of 100 basis points in 2025 to a range of 3.25%-3.50%. However, stronger-than-expected economic growth and inflation’s failure to reach new lows have prompted officials to call for a slower pace of rate cuts heading into the new year. As a result, the market now projects that the Fed could cut rates by 75 bps next year.

• In our view, the Fed’s ability to cut rates will be determined by inflation’s progress in the first three months of the year. As the chart above illustrates, the start of this year saw the widest gap between monthly PCE price inflation increases and its three-year pre-pandemic average. This divergence led several officials to question the need for rate cuts in 2025. Consequently, if inflation remains stubbornly high at the beginning of next year, the central bank may be less inclined to implement the projected rate cuts. This could mean that the Fed may end up cutting less than what the market currently expects.

Dow Jones Trouble: Recent S&P 500 and NASDAQ gains contrast the declining Dow Jones, highlighting the increasing influence of tech giants.

• The Dow Jones Industrial Average Index extended its losing streak to nine consecutive days on Tuesday, marking its longest downturn since the Jimmy Carter administration. The Dow Jones Index has not benefited from the rally in tech stocks, as only four of the Magnificent 7 companies (Amazon, Microsoft, Apple, and Nvidia) are included. Additionally, the index has been significantly impacted by the struggles of healthcare services following the tragic killing of the UnitedHealth CEO and the incoming administration’s plans to regulate pharmacy benefit managers.

• The poor performance of the Dow Jones is another example of how concentrated equity markets have become in recent years. Tech stocks have been the primary drivers of the S&P 500’s performance this year, with the Magnificent 7 accounting for nearly 60% of the gains, which allowed them to increased their combined share of the S&P 500 to nearly 35% in the first six months of the year. This increased concentration means the overall index performance is highly sensitive to changes in sentiment toward the tech sector.

• Going into next year, we expect momentum to continue playing a major role in equity performance. As a result, we anticipate that mega cap tech companies will thrive as long as market expectations remain relatively unchanged. We believe that in 2025 many investors will flock to familiar names in search of safety amid concerns about elevated inflation and uncertainty regarding fiscal and monetary policy. However, the increased concentration of the S&P 500 suggests that the index is highly susceptible to exogenous shocks, which we will be monitoring closely in the coming months.

Brazil’s Problems Deepen: Brazilian markets have plummeted as investors have sought to reduce their exposure to Latin America’s largest economy due to concerns over its widening deficit.

• On Tuesday, the Brazilian real (BRL) plummeted to a record low, prompting investors to reduce their exposure to the country’s debt and equities. The market turmoil was triggered by the lower house’s approval of a spending package that included weakened measures to curb spending if revenue falls short of expectations. While the central bank intervened to stabilize the currency, serious concerns persist about Brazil’s fiscal situation, which is likely to continue weighing on investor sentiment, especially as lawmakers prepare to pass three additional proposals.
• The country’s budget deficit has reached 10% of GDP, exceeding the levels recorded during President Luiz Inácio Lula da Silva’s first term. In response, Lula proposed a plan to cut annual spending by 70 billion BRL ($11.5 billion). However, the inclusion of income tax breaks in the bill have raised concerns over the budgets’ ability to rein in the deficit. Compounding the issue is the speculation that lawmakers may weaken provisions affecting social spending. Additionally, a key measure to rein in military pension expenses has been delayed until next year, further casting doubt on the plan’s timely implementation.

• Brazil’s reluctance to make tough decisions to curb spending suggests that the central bank will likely bear the brunt of the burden. To prevent the country’s widening deficit from exacerbating inflationary pressures, the Central Bank of Brazil may need to tighten financial conditions. This policy could eventually weigh on the country’s GDP growth potential and negatively impact equities. However, if lawmakers adopt a stricter stance on the budget or if government revenues exceed expectations, investors may reconsider their outlook on Brazil.

In Other News: Nissan and Honda are reportedly discussing a potential merger as a strategy to increase their size and competitiveness in the automotive industry. Meanwhile, congressional lawmakers have reached an agreement to avert a government shutdown, which is expected to alleviate market uncertainty.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with new developments in Japanese monetary and energy policy. We next review several other international and US developments with the potential to affect the financial markets today, including a shock resignation by Canada’s finance minister and signs that President-elect Trump wants to reduce the US defense budget to help pay for extending his 2017 tax cuts.

Japanese Monetary Policy: As investors focus on the Fed’s monetary policy decision tomorrow (see below), the Bank of Japan will be holding its latest policy meeting on Thursday. Based on current futures trading, investor opinion is basically split on whether the BOJ will hike its benchmark interest rate or hold it steady at the current level of 0.25%. BOJ policymakers remain keen to normalize Japan’s interest rates if inflation and economic growth meet expectations, but government officials want rates to remain low to boost growth rates.

Japanese Energy Policy: The government has released a new study showing nuclear power will be Japan’s cheapest baseload electricity in 2040, at 12.50 JPY ($0.08) per kilowatt-hour. In its prior long-term forecast, the government said natural gas would be Japan’s cheapest baseload electricity in 2030, but the new study shows that emissions mitigation requirements would push its all-in cost above that of nuclear over the longer term. The findings support the government’s plan to double down on nuclear power in Japan’s long-term energy mix.

• Notably, the study also showed that the all-in cost of solar-generated electricity would exceed that of nuclear power in the long run. According to the study, that’s due to the need for batteries and other equipment to make up for solar energy’s intermittent nature.
• The findings are consistent with our expectation for increased nuclear energy investment around the world in the coming years. That, along with China’s program to boost its arsenal of nuclear weapons, will likely buoy uranium prices in the coming years as well.

China: Illustrating how China is prioritizing its effort to dominate the world’s electric-vehicle market, the Foreign Ministry has reportedly begun recruiting science and technology graduates to serve in embassies around the world. As part of the recruitment process, the candidates were tested on their knowledge of Communist Party ideology and their understanding of EVs. Once hired, the candidates will presumably use their embassy positions to help open those local markets to Chinese EVs.

United Kingdom-China: The Labour Party government of Prime Minister Starmer has reportedly decided to downgrade its promised in-depth study of UK-China relations and the security and economic risks they entail. According to the sources, the decision to opt for a quicker, more cursory, less critical review was made to avoid spoiling Starmer’s effort to repair the UK-China trade relationship.

• Starmer is desperately trying to re-ignite the UK economy, which has been in a funk ever since Brexit and the coronavirus pandemic. One problem has been a loss of trade with the European Union since Brexit and the UK’s failure to coax the US into a free-trade deal to replace it. With the US now so isolationist and protectionist, Starmer is turning to China for new trade opportunities and potentially better growth.
• The situation illustrates the geopolitical risks the US faces as it adopts more isolationist and protectionist policies, including potential new tariffs and other trade barriers against even its core allies. As noted in our new Geopolitical Outlook for 2025, those policies could weaken the cohesion of the US geopolitical bloc. In a worst-case scenario, they could even incentivize US allies to draw closer to adversary countries such as China, Russia, Iran, or North Korea.

Turkey-Syria: According to US officials, Turkey and its militia partners are building up troop levels on the Syrian border in apparent preparation for a large-scale incursion into the country. Ankara’s most likely goal would be to seize Syrian territory populated by US-backed ethnic Kurds before President-elect Trump takes office again in the US.

• The Syrian Kurds and their brethren in Turkey dream of forming a Kurdish republic on territory taken from both Turkey and Syria. To press the issue, a Kurdish terrorist group has long staged attacks in Turkey. Therefore, Ankara has a strong incentive to take control of the Kurds’ territory while the Syrian government is largely dysfunctional following the fall of President Assad last week.
• Turkey’s move would come as Israel continues to attack Syrian military sites to keep Assad’s chemical weapons and other advanced arms away from the new Syrian government or terrorists.
• The possible Turkish incursion is a reminder that the fall of Assad doesn’t necessarily mean a quick return to peace and stability in Syria or the broader region. The volatility means the region’s globally important energy resources will remain at risk of disruption in the near term.

Argentina: New data shows that gross domestic product grew by a seasonally adjusted 3.9% in the third quarter, marking an end to the sharp recession that began in late 2023. The growth came largely from rebounding consumer spending and corporate investment as Argentines adjusted to the Milei government’s sharp budget cuts and deregulation program. In response, the yield spread between Argentine and US government bonds fell to 677 basis points, versus more than 2,000 basis points one year ago.

Canada: Finance Minister Chrystia Freeland, who had been one of Prime Minister Trudeau’s most loyal and trusted aides, abruptly tendered her resignation yesterday and released a blistering letter attacking Trudeau’s plan to release fiscal stimulus ahead of US President-elect Trump’s threatened import tariffs. Instead, Freeland argued that Canada should keep its fiscal powder dry to address any fallout from US policy in the future.

• In the latest opinion polls, support for Trudeau and his center-left Liberal Party is far below that of the center-right Conservative Party. Freeland’s resignation will therefore add to the enormous pressure on Trudeau to resign. However, Trudeau has steadfastly refused to give up and said he intends to campaign for re-election next year.
• On top of Trump’s threatened tariffs against Canada, the increasing political and policy uncertainty in the country is likely to discourage new investment and consumer spending. That will probably weigh on both economic growth and Canada’s financial markets well into 2025.

US Monetary Policy: The Federal Reserve begins its latest monetary policy meeting today, with its decision due tomorrow at 2:00 PM ET. Based on current futures trading, the policymakers are widely expected to cut the benchmark fed funds interest rate by 25 basis points to a range of 4.25% to 4.50%. The bigger question is what their updated economic and financial market forecasts will look like.

• In their September projections, the policymakers stated that they expected to cut the fed funds rate by another 1.00% over 2025, to a range of 3.25% to 3.50% by year’s end. They expect perhaps another couple of small rate cuts in 2026.
• Given the US economy’s continued growth and sticky price pressures, we would not be surprised if the new projections this week call for fewer future rate cuts and a terminal rate higher than what investors currently expect. That could set the stage for some financial market volatility when the decision is released on tomorrow.

US Defense Budget: According to Axios, President-elect Trump has told former Fox News commentator Pete Hegseth, his nominee for defense secretary, to prepare for a smaller US military budget. The report quotes Trump as telling Hegseth, “I expect you to do more with less. They’re spending too much money, and we’re not getting anything for all that money.” The report is the clearest sign yet that Trump may not follow the traditional Republican playbook of hiking defense spending to support a “peace through strength” foreign policy.

• We continue to believe that today’s increasing international tensions and greater assertiveness by the China/Russia geopolitical bloc will lead to bigger defense budgets worldwide in the coming years. Indeed, that’s already happening in much of Europe and Asia. However, we’ve also noted that US political polarization, isolationism, and “America First” sentiment have held the Pentagon’s budget in check. Trump’s statement is a warning that the US defense budget could face outright cuts.
• We suspect that Trump wants to find savings in the defense budget to help pay for his tax cuts and other promised initiatives.
• Against this backdrop, the major defense firms in Europe and Asia may have better prospects than the major US defense contractors, which would likely face reduced funding for the big, expensive, “exquisite” weapons systems they specialize in.
• On the other hand, some of the US’s savings will likely be channeled toward smaller, more innovative start-ups or young companies with defense-related technology, such as drone makers and artificial intelligence software providers. Those small, innovative defense firms could eventually become great growth stories.
• To reiterate, though, this scenario is probably not yet set in stone. President-elect Trump’s coalition includes many traditional defense hawks who want to boost the defense budget to counter China and its bloc. For example, the Republicans’ former Senate Majority Leader, Mitch McConnell, has a new article for Foreign Affairs magazine arguing for building a stronger US military rather than cutting it.

US Industrial Policy: The Department of Energy has granted a $755 million loan to Australian firm Novonix to build the US’s first large-scale synthetic graphite plant in Chattanooga, Tennessee. The investment aims to break the US’s dependency on China for the graphite needed in electric-vehicle battery production. It’s also another example of how growing US-China frictions are fracturing global supply chains and prompting re-industrialization in the US.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with the latest signs of economic weakness in the eurozone. We next review several other international and US developments with the potential to affect the financial markets today, including the naming of a new prime minister in France, disappointing economic data from China, and a few words on monetary and fiscal policy in the US.

Eurozone: In a speech today, European Central Bank Chief Lagarde signaled that she believes the ECB has re-established price stability in the region and can now continue to cut interest rates. According to Lagarde, “The direction of travel is clear, and we expect to lower interest rates further.” The statement confirms widely held expectations that the ECB will continue to cut rates to support the eurozone’s flagging economic growth. Reflecting that, the euro today is trading slightly weaker at $1.0503, near its lowest level in more than a year.

• In the latest evidence of the eurozone’s economic malaise, S&P Global and Hamburg Commercial Bank today said their December composite purchasing managers’ index came in at just 49.5, slightly higher than last month but still below the level of 50 that indicates expansion.
• The weakness stemmed largely from contracting activity in the manufacturing sector, while the service sector posted growth.

Germany: To set the stage for new elections, parliament is expected to hold a confidence vote today on Chancellor Scholz, who leads the center-left Social Democratic Party. If Scholz loses as anticipated, the elections would likely be held in mid-February, and the winner would probably be Friedrich Merz of the center-right Christian Democratic Union. However, the ascendant far-right Alternative for Germany party is considering tactically voting for Scholz to keep him in office and delay the rise of Merz, who wants to increase Germany’s support for Ukraine.

France: Days after his previous prime minister was deposed in a no-confidence vote, President Macron on Saturday named veteran centrist politician François Bayrou to replace him. Bayrou is expected to name his ministers in the coming days. However, Bayrou will face the same political problems that the previous prime minister faced, such as his proximity to the unpopular Macron and the fact that his coalition’s minority government can easily be toppled if parliament’s large left-wing and right-wing blocs decide on another no-confidence vote.

• Bayrou’s priorities now will be to pass a special law to roll over the 2024 budget and then to pass a formal 2025 budget that begins to address France’s yawning budget deficit, which has started to spook investors.
• The most likely scenario going forward will be for France to face an extended period of political and policy uncertainty, with negative implications for the French economy and financial markets.
• Underscoring the bleak prospects for France’s budget consolidation and improved economic competitiveness, Moody’s on Saturday unexpectedly cut the country’s sovereign debt rating to Aa3, three notches below its top rating. However, in a sign that France’s troubles are already priced into the markets, the yield on the country’s benchmark 10-year government bond is barely changed this morning at 3.029%.

United Kingdom: On Sunday, the UK officially joined the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, as originally announced last year. Acceding to the TPP marks Britain’s biggest trade deal since Brexit, granting lower tariffs and easier trade rules with countries including Japan, Australia, New Zealand, Canada, Mexico, Chile, and Peru.

• Since the US isn’t a member of the TPP, the economic benefits of accession are limited. London estimates that joining the TPP will only boost the UK’s annual economic output by about 2 billion GBP ($2.5 billion) a year in the long run — less than 0.1% of gross domestic product.
• The more important impact of Britain’s accession may geopolitical. As a full member of the trade pact, Britain can now influence whether applicants China and Taiwan may join the group.

United Kingdom-China: British authorities have banned a suspected Chinese intelligence agent from re-entering the country after discovering he had ties to Prince Andrew (the king’s brother). The authorities have reportedly discovered that the Chinese agent gave money to the prince, who then gave the agent access to Buckingham Palace, the Ministry of Defense, and meetings with former UK prime ministers.

• In response, King Charles is reportedly considering banning Prince Andrew from Buckingham Palace’s Christmas celebrations. The reports also claim the prince could be forced to move to the Gulf region for asylum.
• Both China and Russia have adopted aggressive, no-holds-barred approaches to their intelligence gathering and secret influence campaigns against the West. If the allegations against Prince Andrew are true, it would only be the latest example of how successful those intelligence operations have become. Western media and voters have been quite complacent about these attacks to date, but there is some chance that an especially egregious operation could spark pushback and ratchet up geopolitical tensions.

China: Official data from this weekend showed November industrial production was up 5.4% from the same month one year earlier, versus a rise of 5.3% in the year to October. Fixed-asset investment in January through November was up 3.3% year-over-year, versus 3.4% in the January-October period. In contrast, November retail sales were up just 3.0% on the year, after a 4.8% rise in the year to October. The data suggests Beijing’s recent economic stimulus program has boosted corporate activity, but consumers remain more skeptical.

South Korea: On Saturday, Parliament impeached President Yoon for his attempt to declare martial law on December 3. Fully 204 of the chamber’s 300 members voted in favor of the measure. Prime Minister Han Duck-soo will now be acting president until the Constitutional Court decides whether to affirm the impeachment, which could take as long as 180 days. If the court affirms, new presidential elections would have to be held within 60 days.

• The court is currently short-handed due to recent resignations and a stalemate over their replacements. Therefore, all six of its current members would have to vote to affirm the impeachment before Yoon can be thrown out of office.
• Yoon therefore probably still has a chance to keep his position. Nevertheless, because of his deep unpopularity and the strength of the political forces against him, South Korea could be in political limbo for some time, which will likely weigh on the country’s economy and financial markets.

US Monetary Policy: The Federal Reserve will hold its latest monetary policy meeting this week, with its decision due on Wednesday at 2:00 PM ET. Based on current futures trading, the policymakers are widely expected to cut the benchmark fed funds interest rate by 25 basis points to a range of 4.25% to 4.50%. The bigger question is what their updated economic and financial market forecasts will look like.

• In their September projections, the policymakers expected to cut the fed funds rate by another 1.00% over 2025, to a range of 3.25% to 3.50% at year’s end. They expected perhaps another couple of small rate cuts in 2026.
• Given the US economy’s continued growth and sticky price pressures, we would not be surprised if the new projections this week call for fewer future rate cuts and a terminal rate higher than what investors currently expect. That could set the stage for some financial market volatility when the decision is released on Wednesday.

US Fiscal Policy: The Wall Street Journal today reports that Republican leaders in Congress are leaning toward prioritizing tax cuts over measures to reduce the federal budget deficit when the new legislative term starts next year. To mask the impact of extending the 2017 tax cuts, some of the leaders reportedly advocate changing the official methodology for calculating how their decisions affect the budget. The debate suggests at least some Republicans are looking to do whatever it takes to extend the tax cuts, despite the impact on the deficit.

• Under current budget rules, the baseline deficit in future years is the estimated shortfall assuming today’s legislation is in place or expires as currently written. The 2017 tax-cut law expires at the end of 2025, so under today’s rules, the baseline deficit for 2026 and beyond would reflect a snap-back of tax rates to the higher levels prevailing before 2017, i.e., tax revenues would likely rise, and the baseline deficit would be smaller.
• The proposal being considered would assume the 2017 tax cuts don’t expire, even though extending them would require an act of the new Congress. Under this methodology, baseline tax rates would stay low, and the assumed deficit for comparison would remain large. In other words, extending the tax cuts would be “free,” and deficit impacts would be calculated only for new measures, such as President-elect Trump’s promise to eliminate taxes on workers’ tips.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is digesting the latest data from Broadcom as it assesses the outlook for chipmakers heading into the new year. In sports, LeBron James’s son achieved a career-high 30 points during his first G League road game. In today’s Comment, we delve into the incoming Trump administration’s latest tax proposal, the impact of the automation debate on inflation, and the factors behind the British economy’s recent struggles. As always, our report includes a summary of key international and domestic data releases.

Tax Details: The Trump administration provided a glimpse of what may be included in a tax package on Thursday.

• Economic advisors within the administration have proposed doubling the State and Local Tax (SALT) deduction cap from $10,000 to $20,000. This measure is positioned as a compromise to address the concerns of residents in high-tax states, following the president’s campaign promise to eliminate the cap entirely. The proposal aims to improve middle-class living standards while mitigating perceptions of favoring the wealthy. The move also suggests that the incoming president may take a more pragmatic approach in office than he did on the campaign trail.
• The decision to increase the SALT deduction cap rather than eliminating it was driven by concerns over the growing national deficit. Before the election, Treasury yields rose as investors worried about an increase in government borrowing to finance additional spending. Initial estimates projected that these spending plans would add $7.5 trillion to the deficit over the next decade. While the administration expressed optimism that stronger GDP growth could potentially offset these costs, recent Congressional Budget Office estimates suggest a more mixed economic impact from the tax changes.

• The market’s assessment of the future US budget deficit may be overly pessimistic. As previously discussed, the Trump administration, like its predecessors, is likely to temper its campaign promises to make them more budget friendly. A potential compromise could involve extending the Trump tax cuts for an additional four years, rather than making them permanent. That said, we remain most optimistic about the proposed corporate tax rate cut, as it could be essential in securing continued corporate support while implementing potentially less business-friendly policies.

Labor Fights Back: The possibility of another port workers’ strike in January will likely test the new president’s ability to balance the interests of labor and capital.

• President-elect Donald Trump voiced support for the International Longshoremen’s Association, which represents over 45,000 union port workers on the East and Gulf coasts. In October, workers went on strike to oppose employer use of automation. Employers argue that automation is necessary to reduce costs and maintain competitiveness, while the union contends that it will lead to significant job losses. On Truth Social, Trump argued that “the amount of money saved [through automation] is nowhere near the distress, hurt, and harm it causes for American Workers.”
• The ongoing debate about automation and artificial intelligence (AI) carries significant implications for long-term inflation. Federal Reserve officials believe that productivity gains from technological advancements and increased efficiency could help lower inflation to the 2% target while supporting economic growth. As a result, the implementation of automation and AI will be important if the government would like to pursue tougher immigration and trade policies without negatively impacting inflation.

• Keeping a close watch on the dynamic between labor and capital will be crucial in assessing the president’s ability to navigate opposing factions within his coalition. His primary challenge lies in balancing his goal of bringing down inflation without hurting wage growth. As shown in the chart above, much of the inflation reduction over the past two years has come at the expense of workers. To rebalance this, the Trump administration may need to shift the wage burden away from consumers and onto corporations, possibly by encouraging firms to slow their adoption of certain disruptive technologies.

British Slowdown: The UK economy contracted again, marking the second consecutive month of decline and hindering the Labour government’s growth goals.

• Economic output dropped 0.1% in October, according to the Office for National Statistics. The weak performance was a surprise, as initial forecasts had predicted an uptick. Now, there are concerns that the economy may also contract in the fourth quarter. Following the report’s release, the pound sterling (GBP) weakened by 0.3% against the dollar to $1.26, as investors began to factor in a potential widening gap between UK and US interest rates and weakening GDP growth projections for 2025.
• The decline is a major setback for Prime Minister Keir Starmer’s Labour government, which has made economic recovery a cornerstone of its agenda. The party has pledged to deliver the fastest per capita GDP growth in the G7 for two consecutive years by the end of this parliamentary term — a feat last achieved in the 1970s. However, the goal remains far out of reach, with the UK’s economic growth ranking second to last among G7 countries in Q3.

• The weakness in growth is likely to prompt the Bank of England to lower interest rates more aggressively to prevent the economy from further deceleration. Recent forecasts from policymakers within the BOE projected 0.3% growth in the fourth quarter, leading the group to believe a more gradual approach to rate cuts would suffice. However, the latest negative economic data could necessitate more rapid rate cuts than initially anticipated. Assuming this is correct, we can expect downward pressure on the pound sterling and upward pressure on the US dollar.

In Other News: The Trump administration is reportedly aiming to curb the influence of bank regulators by placing them under the Treasury Department in a move that could have significant implications for the Federal Reserve’s independence. French President Emmanuel Macron has appointed François Bayrou as prime minister in a bid to ease concerns over political instability.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is analyzing the latest PPI data to gauge the Fed’s next move. In sports news, former New England Patriots coach Bill Belichick has agreed to lead the University of North Carolina’s football team. Today’s Comment will explore why Fed policymakers remain concerned about inflation, provide an update on the government’s efforts to avoid a shutdown, and share insights on Canada’s monetary policy. As always, we’ll summarize key domestic and international data releases.

Inflation in Line: The CPI report did not disappoint, but there are still concerns about the future path of inflation.

• According to the Bureau of Labor Statistics, the overall consumer price index accelerated slightly in October. The year-over-year change rose from 2.6% to 2.7%, while the core index, which excludes volatile food and energy, rose 3.3%, roughly in line with the previous month. The rise in inflation was driven by a few components, including transportation and food prices, which both showed signs of acceleration. That said, the report was likely good enough for policymakers to cut rates next week; however, there are still questions concerning the path of monetary policy for 2025.
• Fed officials will remain vigilant for signs of renewed inflationary pressures, especially at the beginning of the year. In the first quarter of 2024, core CPI surged well above its pre-pandemic trend, mainly driven by unexpected spikes in financial services and shelter costs. While price pressures eventually eased throughout the year, this early surge led the Fed to doubt its progress and delay rate cuts until September when a 50-basis-point reduction was implemented. If a similar scenario unfolds in 2025, the Fed could signal an indefinite pause on rate cuts for the year.

• Our primary concern is the potential resurgence of goods inflation driven by tariffs, which could reverse recent progress in moderating price pressures. The last time tariffs were implemented there was a significant increase in durable goods prices, particularly for home appliances. While this didn’t have a major impact on overall inflation then, it could diminish a key driver of disinflation this time. Although we don’t expect this to influence policy decisions at next week’s meeting, it could prompt Federal Reserve officials to adopt a more hawkish stance in 2025.

Spending Gap Bill: Lawmakers are working together to put together a stop gap spending bill to prevent the government from shutting down on December 20.

• The House of Representatives passed an $895 billion defense spending bill on Wednesday, the first of several appropriations bills needed to fund the government. While this bill garnered bipartisan support, upcoming appropriations are expected to be more contentious. Lawmakers face disagreements over the scale of disaster relief for Hurricanes Milton and Helene and whether to increase funding for agencies like the DOE and the EPA. Despite these challenges, there’s hope for a short-term funding agreement to keep the government open until the new year.
• In the post-financial crisis era, political infighting has forced lawmakers to repeatedly extend government funding with temporary measures known as continuing resolutions. Only once since 2009 has more than one appropriations bill been passed before the October 1 deadline. These stopgaps prevent government shutdowns but also prolong the appropriations process and contribute to the ballooning budget deficit. The government has already relied on five continuing resolutions this year, which has helped push the deficit to nearly $2.0 trillion this fiscal year. This puts it on track to be the largest deficit outside the pandemic era.

• The dispute over the budget will set up a showdown regarding how to raise the debt ceiling, which expires January 1. The ongoing political infighting over the budget is likely to raise investor concerns about the US government’s ability to address its fiscal challenges. The two major rating agencies have already downgraded the US credit rating, citing concerns about partisan gridlock, which could prevent a bipartisan agreement to reduce the deficit. As a result, we anticipate that continued political bickering over the debt will likely impact long-term interest rates in the future.

BOC and Tariff Threats: The Bank of Canada slashed rates by 50 basis points to stimulate its economy but warned of economic risks due to trade tensions with the US.

• The central bank lowered its policy rate to 3.25%, its lowest level since September 2022. Following the reduction, the central bank signaled a more gradual approach to future rate cuts. This shift in tone suggests that larger rate cuts may be less likely, and the central bank could adopt a more modest approach to its guidance as it seeks to stimulate the economy. During the press conference, Bank of Canada Governor Tiff Macklem warned that the economic outlook has deteriorated due to the threat of tariffs against Canada.
• The threat of tariffs poses a significant risk to the Canadian economy, which is already facing a slowdown. In the third quarter of 2024, GDP growth decelerated from an annualized pace of 2.2% to 1.0%. This slowdown was primarily driven by a decline in investment spending, which has been a drag on GDP for five of the last six quarters. The threat of a trade war could intensify business uncertainty, making it harder for companies to justify capital expenditures and job creation in Canada.

• A potential trade war with the US could significantly harm Canada’s economy, as roughly 20% of its GDP is tied to trade with its southern neighbor. To mitigate the negative impact of potential tariffs, the Bank of Canada is likely to ease monetary policy further to make it easier for households and firms to borrow. This could lead to a depreciation of the Canadian dollar relative to the US dollar, but it could also make Canadian exports more competitive globally.

In Other News: President-elect Trump has asked Chinese President Xi Jinping to join him at his inauguration as a possible olive branch. This move suggests a possible easing of tensions between the two sides. Microsoft shareholders voted down a measure that would allow the company to add bitcoin to its balance sheet, indicating that crypto is becoming more widely accepted. The European Central Bank voted to cut its benchmark policy rate by 25 bps to 3.00%.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently digesting the latest inflation data. In sports news, two-time All-Star left-handed pitcher Max Fried inked a $218 million deal with the New York Yankees. Today’s Comment will delve into our thoughts on Trump’s pick to head the Federal Trade Commission, the potential for a stronger dollar in 2025, and the latest developments in South Korean politics. As always, we’ll conclude with a roundup of key domestic and international economic data releases.

Trump Anti-Trust Busting: The president-elect has chosen Andrew Ferguson to lead the Federal Trade Commission (FTC), signaling the administration’s intent to moderate the agency’s stance on monopoly power.

• The new agency head is set to continue the FTC’s oversight of Big Tech, but will likely leave other sectors alone. He is also expected to adopt a softer approach to AI regulation and take a more lenient stance on merger standards compared to his predecessor, Lina Khan. His primary focus will be safeguarding free speech on social media platforms. In this role, which does not require Senate confirmation, he will oversee ongoing cases against tech giants, which could pave the way for the breakup of companies like Google and Meta.
• Ferguson is expected to limit the regulatory body’s authority as he looks to create the pro-innovation environment pushed by the president. He has publicly opposed measures like judicial job protection, challenged the agency’s rule-making authority, and argued against regulations that could stifle AI innovation. His appointment will likely bolster business optimism, as evidenced by the recent spike in the National Federation of Independent Business’s Small Business Optimism Index. In November, it surpassed its long-term average of 98 for the first time in 34 months.

• A less stringent FTC could boost the broader equity market, as industries like finance, energy, and pharmaceuticals face reduced regulatory scrutiny. These industries have traditionally been focal points for regulatory actions concerning consumer protection. However, the outlook for tech stocks remains uncertain, as they are likely to remain under heightened scrutiny due to concerns about monopoly power and perceived biases against conservative speech. While we see some potential upside in tech, we believe investors may find better value opportunities in other industries as well.

Super Greenback: Hawkish trade policy and relatively restrictive monetary policy are expected to support the dollar in the coming year.

• Reports surfaced Wednesday that Beijing may allow its currency to depreciate next year as a potential response to a looming US trade war. The new measure along with additional stimulus from the government is intended to bolster the competitiveness of Chinese exports and revitalize its ailing manufacturing sector. Later today, Beijing is expected to outline its economic plans, including measures to stimulate growth, at its annual economic policy meeting.
• The looming threat of a US trade war has strengthened the dollar significantly against major currencies. Since September, the dollar has appreciated by 4.2% versus the Chinese yuan (CNY), 4.6% versus the Mexican peso (MXN), 6.0% versus the Canadian dollar (CAD), and 6.7% versus the euro (EUR). As trade tensions intensify, growth prospects for these economies may deteriorate, potentially pushing them towards more accommodative monetary policies. Meanwhile, the Federal Reserve’s stance on interest rate cuts remains uncertain, which could also exacerbate the dollar’s strength.

• The strengthening dollar poses a significant risk to the global economy, especially for nations with substantial US dollar-denominated debt. This trend could make the US an increasingly attractive investment destination, particularly if the incoming administration implements its promised tax cuts. For investors seeking international exposure, a prudent strategy would be to prioritize countries with low debt levels and minimal trade exposure to the US. This could involve focusing on nations within the European Union and South/Central America, given their relatively limited import exposure to the US.

Korea’s Turmoil: South Korea is currently looking to pave the way forward as it tries to move past the recent attempt by its president to impose martial law.

• On Tuesday, in a historic move, South Korea’s opposition-controlled parliament approved a government budget without the consent of government ministries. South Korea’s budget has been a major point of contention with proposed cuts clashing with the president’s desire for increased spending. This tension escalated to the point where the president attempted to declare martial law last week. However, South Korea’s unique legislative system allows its lawmakers to implement budget cuts without presidential approval, which is likely to weigh on an already struggling economy and exacerbate political tensions.
• The budget dispute highlights a strategic move by the opposition party to leverage its position and impose austerity measures to both balance the nation’s finances and weaken the ruling party. While the potential economic slowdown could aid in removing the ruling party from power, this questionable approach mirrors global trends as South Korea (like many other countries) navigates the transition from pandemic-era deficit spending to fiscal sustainability. Despite a relatively low debt-to-GDP ratio of 45% compared to Western nations, the country still faces its largest-ever budget deficit.

• While the new budget may not significantly boost economic prospects, it could provide some level of certainty amidst the country’s ongoing crisis. The opposition party is poised to hold a second impeachment vote on Saturday, following the failure of the first attempt due to a lack of quorum. This second attempt may prove more successful, as the head of the ruling party has distanced himself from Yoon following his decision to impose martial law. However, the political uncertainty within the country is likely to persist, as it remains unclear who would succeed Yoon if the impeachment proceeding is successful.

In Other News: Two major mergers faced setbacks as President Biden moved to block the sale of US Steel to Nippon Steel, and a judge halted Kroger’s acquisition of Albertsons. Meanwhile, French President Emmanuel Macron is working with moderates to select a new prime minister within the next 24 hours. President-elect Donald Trump has pledged to fast-track permits for a $1 billion US investment initiative.

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