More Growth, Less Easing
What happened last week?
The S&P 500, Dow and Nasdaq gained 1.11%, 1.21% and 1.13% with the S&P 500 and Dow making new all-time highs on Friday. The big banks kicked off the third quarter earnings season with better-than-expected results while much of Hurricane Milton’s damage appears to have come from wind rather than water.
Amidst the noise, we see the labor market slowly cooling, inflation coming into line, profits growing and the bond market at close to fair value. Add in the normal pre-election market volatility and a case can be made for high quality dividend growers.
What does this mean for investors?
Investors should remember that forecasts for Fed rate cuts have been highly erratic and of limited value. The extent of US rate cuts in 2025 is uncertain, but we believe markets have erased some of the risk of excessively strong easing expectations. More importantly for equity markets, there’s no sign of an overheating economy.
3 Things to Know
A US Recession Is Nowhere in Sight
US inflation has slowed sharply as unemployment moved just gradually higher. Even with an upward surprise in September, headline US inflation has fallen to 2.4% over the past year.
This is below the 2.5% pace we expected for year-end 2024 in our 2024 Wealth Outlook. Following a period of intense upheaval in the pandemic and initial recovery, productivity growth is picking up, allowing output to flourish as profits grow and labor demand slows.
A powerful round of hurricanes has hit the US late in the season, delivering pains for many Southeast residents in a world of multiple, man-made crises (please see last week’s CIO Bulletin for a discussion of the Middle East).
In this case, the historic data are quite clear. Beyond the sad loss of life and property, natural disasters have had limited impact on macroeconomic performance.
Only when productive capital is significantly impaired — as was the case in 2005 and 2017 when the costliest hurricanes (Katrina and Harvey respectively) wrecked much of Louisiana and Texas — could we discern lasting employment losses on a macro scale.
The Citi View: Fed Easing May Not Dip Below 3.5% in 2025
After a “big cycle” in 2020-2022, global markets have continued to feel aftershocks, arguably “mini cycles.” Arguments over where the Fed would stop tightening (some said at 6-7% for cash rates) are over.
In August, some argued that an economic collapse had finally begun and the Fed would need to quickly act with “emergency” easing steps.
After hinting for much of the year that restrictive US monetary policy could someday relax a bit, Fed Chair Powell delivered a 50-basis point rate cut in September. The move sparked much debate within the Federal Open Market Committee, just as it did in markets.
Action was a bit later than we suspected coming into 2024, but also a bit larger to “reward our patience.” The extent of the easing this year may be similar to our initial expectations or just a bit more aggressive.
How Will the Global Economy Fare in 2025? It Largely Depends on the US
The power of the US President and policy differences of the two candidates are significant enough to generate different outcomes in markets favoring either domestic or international assets.
Continued Fed easing and declines in the US dollar might be clearer if Harris continued the Biden administration’s policy course. A return of Trump to the White House with a “Red Sweep” of Congress would deliver tariffs and perhaps new domestic tax cuts, boosting the dollar and limiting the extent of Fed easing.
In either case, however, markets may quickly adjust to these conclusions. China’s incredibly swift repricing of macro policies over just two weeks might be a good indication of how markets can swiftly adjust to public information.
The post-US election environment can create a sharp movement in asset prices. History shows that pre-election periods — most acutely the month before — tend to be biased toward negative returns on uncertainty and apprehension.
The last October before a US election that posted a positive equity market return was 2004. No President delivers magical cures, but as uncertainty fades, post-election returns have been biased positive in all but the most extreme negative economic environments (November/December 2008 is the last example).
Of course, in a world of AI data mining, it would not surprise us if investors attempt to act on this historical pattern, confounding a repeat (past performance is no guarantee of future results!)
See our weekly CIO Strategy Bulletin for more details