Last week was full of news and market volatility. The Federal Reserve cut rates as expected, but delivered post release comments that spooked investors enough to send the Dow down more than 1000 points. Almost parallel to the FOMC decision, Congress went through one of its down to the wire fiascos before approving a continuing resolution (CR) to keep the government operating until March.
While the news will have little direct impact on the course of the economy over the next several months, the messaging was enlightening. Let’s start with CR mess. Once again Speaker Johnson had to navigate a path forward with Democratic support as his narrow Republican majority wasn’t unified. To gain that support, the package was filled with pork barrel spending that would have exploded the deficit beyond $2 trillion. Just as he cobbled together enough votes to send the legislation to the Senate, the team of Musk and Trump torpedoed the bill via dozens of social media posts. While the method and messaging were pure Trumpian, chaotic and always at the 11th hour, the original bill put together at mid-week, more than 1500 pages in length, deserved to be torpedoed. It was exactly what Trump and Musk have been railing against over the last several months.
But the saga doesn’t stop there. Trump and Musk demanded that along with a slimmed down CR, Congress pass an increase in the debt ceiling that would last until at least 2027. Here’s where the story gets interesting. For months investors have been looking toward the coming Trump administration almost as a benevolent dictatorship featuring low taxes, much less regulation, and deportations. In a country ruled by a system of checks and balances between Congress, the Courts, and the White House, what lay ahead was to be a concentration of power within the Executive branch with Congress and courts set to simply rubber stamp the wishes of the White House.
What we saw last week was quite different. Republicans in the House once again demonstrated their lack of cohesiveness. Trump reminded everyone that during his first term he governed via chaos and there is no reason to expect anything different this time around. While he is surrounding himself this time with loyalists who will largely follow through on these wishes, there are things out of his control. Democratics, burned by his 11th hour busting of a CR they endorsed, had no appetite to extend the debt ceiling. Leave that dirty work to Republicans when they take office. Conservative Republicans in the House don’t want to raise the debt ceiling at all. They were elected as deficit hawks. Thus, the messaging last week was that the next several months are hardly going to be smooth sailing. The Republicans will have a majority in the House of no more than five seats. Getting more than 215 Republicans (out of 220) to vote for anything given their differing political views, won’t be a layup.
The political uncertainty surrounding the CR was clearly a factor in the Federal Reserve’s messaging last week. Its 25-basis point rate cut was universally expected. But beyond that there was lack of unanimity regarding the future outlook. Recent inflation data suggests getting from 3% to 2% won’t be a cake walk. Further rate cuts may not be needed at all. A pause in January is almost a guarantee.
This Fed prides itself as being very data dependent. The slowing decline in inflation may have been enough to evoke caution as to the path of coming rate cuts. Data, of course, is backwards looking. The Fed does canvas its member banks to get real time data, if only anecdotal. And each Committee member looks ahead based on information at hand. However, in its post meeting messaging it was clear that the level of uncertainty today is much higher than normal. And it isn’t just about inflation. Trump promises tariffs. We don’t know how big and when. He promises deportations. A key Fed mandate is to create a healthy environment for full employment without inflationary wage pressures. How will deportations affect that outcome? Again, the answer is unknown. Musk and the DOGE team promise fiscal discipline. How will that play out? How long will it take?
Clearly, uncertainty pervaded the Fed messaging. The next FOMC meeting doesn’t conclude until January 29, one week after inauguration. While Trump’s first day salvo of Executive Orders will have been issued by then, the economic impact won’t be known for some time. The next meeting is in mid-March. Committee members will know more about inflation’s path by then. They will also “listen” to the market, looking at where longer dated rates are heading as well as the shape of the yield curve. While the Fed could move rates in March, more than likely they won’t unless either inflation and/or the unemployment rate move unexpectedly between now and then.
As I noted at the top of this Comment, none of what happened last week will impact the overall economy meaningfully. Modest changes in the yield curve aren’t going to affect spending much. Directionally, Trump is likely to get movement on most of his agenda. But what we learned last week, and what we learned during his first term in office, is that much of what he accomplishes comes amid chaos. Financial markets generally don’t like chaos. Surprises bring instant reaction, often negative. Think back to the reaction to the announcements of tariffs on steel and aluminum in his first term. Or simply to the change in dot plots accompanying the FOMC decision last week.
What we also learned last week is that while Trump and Musk can exert strong pressure, members of Congress must listen to their own constituents. What a conservative
Republican hears in a deeply conservative rural district in the South may be very different that what a moderate hears in the Northeast. Threats of primary challenges can go only so far.
All this suggests that the future outlook today isn’t much different than what it was a week ago. But investors had to survive two buckets of cold water, one suggesting interest rates may stay higher for longer, and one suggesting getting legislation done is going to be more chaotic and tougher to get across the finish line than previously thought.
Nothing last week changes earnings forecasts. A slight bump in long-term interest rates contributed slightly to the sharp decline Wednesday afternoon in equity prices. But valuations shouldn’t change based on the facts of last week’s events. However, uncertainty elevates risk. And risk is a detriment to valuation. Thus, if chaos continues during the early part of the Trump administration, volatility should rise and the path forward will be bumpier than expected. Equity markets haven’t seen a 10% correction since the fall of 2023. Stocks rose by 20%+ in both 2023 and 2024. They haven’t done that three years in a row since the late 1990s. 2025 can still be an up year for stocks if inflation remains contained and the unemployment rate stays below 4.5%. Earnings growth could accelerate from 2023 if productivity gains continue. However, these are lots of buts. How much will tariffs impact economic growth? Who will fill the jobs previous held by deported immigrants? Can the deficit be contained close to $2 trillion? What will be the yield on 10-year Treasuries a year from now?
Thus, I expect last week to be a harbinger for the coming months. I don’t expect 1000 point moves every week but I do expect them to be more frequent than they have been for the last two years. In addition, there is still too much speculative fever. Last week did little to change that. Tread carefully over the next 90 days until we get a better sense of the ability of the Trump team to get the major pieces of his economic puzzle in place.
Today, former marathon champion Bill Rodgers is 77. Actress Susan Lucci turns 78.
James M. Meyer, CFA 610-260-2220