Economic Outlook
- Trump’s election will bring changes in policy
- Inflation hits a flat spot
- Hiring impacted by hurricanes and strikes
Summary
Donald Trump won a decisive victory to become only the second president in history to win a non-consecutive second term in office (Grover Cleveland was the first). Trump made many policy commitments on the campaign trail that could have a meaningful impact on our economy. If history is any indicator, some of those policies, but not all, will be enacted. We’ve summarized some potential implications of those initiatives:
Regulation
Trump has promised a return to a more “laissez-faire” economy with fewer regulatory constraints and less government oversight. Of all his initiatives, this could be the most sustainably supportive of economic growth. There could be negative consequences to the environment, and it remains to be seen how this might impact areas such as food safety and medical care. However, the steady accumulation of government regulation has been a burden and a constraint to many American businesses and even modest relief would be supportive of growth. Financial institutions and the energy industry could be the primary beneficiaries.
Taxation
We can safely assume that many of the tax reductions from the 2017 Tax Cuts and Jobs Act that were set to expire in 2025 will be extended, made “permanent”, or, in some cases, even expanded. This act reduced corporate taxes to a single, flat rate of 21%, dropped the top individual tax rate from 39.6% to 33%, and dropped many of the other individual tax brackets by a similar amount. It increased the standard deduction, eliminated the individual mandate for health care coverage, and raised the Child Tax Credit. It raised the estate tax exemption to $13.6 million and enhanced certain features of retirement savings accounts. During his campaign, Trump promised to lower the corporate tax rate to 15%. Any such reduction will have to pass Congress, and it is not clear how or whether such a reduction will be paid for. Even though Republicans control both houses of Congress, further tax reductions may face some opposition. In the absence of an offset in federal revenues, this provision would expand our already ballooning deficit. At the same time, any cut in the corporate tax would make American businesses more profitable and competitive.
Spending
Trump has enlisted the support of Elon Musk and Vivek Ramaswamy for his initiative to cut government spending. Real opportunities exist for progress on this front, and any reduction in spending will help reduce the deficit and our spiraling national debt. This initiative will also have to come to grips with the fact that 34% of federal spending is comprised of Social Security and Medicare. All entitlement programs together, including veterans’ benefits, make up 62% of all government spending. These programs are popular, considered “untouchable,” and directly benefit many voters. Our national defense makes up another 18% of federal spending. Interest on the debt is now at 14% and is the fastest-growing part of the national budget. Nevertheless, change occurs at the margin, and any reduction in federal spending will slow the rate of borrowing. A reduction in the growth of the national debt could set up a virtuous cycle by slowing the rate of increase in interest spending. Any meaningful reduction in federal spending would reduce the rate of new issuance of Treasury debt, which in turn could reduce upward pressure on interest rates and free up capital for private investment.
Trade
Trump has threatened a 60% tariff on goods imported from China and a 10–20% tariff on all other imports. Such tariffs, if implemented, would land like a grenade in the heart of global trade. Such tariffs would be highly inflationary, at least in the near term. America imports half of a trillion dollars in goods from China, including many critical parts for finished goods manufactured here. Tariffs are an added cost to any import that’s ultimately paid by the consumer and are therefore inflationary. There would be retaliation by other countries for such tariffs, and that retaliation would disproportionately impact American farmers. In the end, the threat of tariffs may be more important than their actual implementation. If they bring trading partners to the negotiating table, concessions may be gained that open markets for American-made goods abroad. Some level of tariffs could encourage the development of new manufacturing in the US, but if they operate as a subsidy, the production they encourage could also prove to be relatively inefficient. Any revenues gleaned from tariffs actually imposed would help reduce the deficit, although gains from this source would be small relative to the tax cuts mentioned above.
Growth
- US GDP came in at 2.8% for Q3 ‘24
- US still leads the developed world in growth
Real GDP for the US came in at a solid 2.8% in the third quarter of 2024, based on the first estimate. That measure of growth was also up 3.0% in the second quarter. Consumer spending continues to be the engine of growth. Personal consumption grew 3.0% year over year, and the quarterly increase was the strongest in six quarters. Real spending was up 6.0% on goods and 2.6% on services. Services comprise a much larger portion of the US economy. Disposable personal income was up 3.2% but has been slowing in recent months. Business spending was also strong. Spending on equipment was up 11.1% in Q3. Aircraft purchases were a supporting factor that can prove volatile from quarter to quarter. Spending on computers was also strong. Smaller gains were made in business structures and intellectual property investment. Spending on residential property was down for the second consecutive quarter, owing primarily to high interest rates and low inventories. US growth would have been stronger still if not for an 11.2% increase in imports which subtracts from domestic GDP. US exports grew an impressive 8.9%. Final sales, a less volatile indicator of growth, were up 3.2%. The US economy continues to be the envy of the developed world. It is presently strong enough to show momentum going into the final quarter of the year and perhaps even into 2025. Growth is also strong enough to complicate the Federal Reserve’s continuing battle against inflation. A hot economy tends to be inflationary.
Employment
- Monthly payroll increases collapsed to 12,000 in October
- Blame hurricanes and strikes
- Unemployment remains low at 4.1%
The US economy added a dismal 12,000 jobs in October, and the unemployment rate held at 4.1%. The payroll addition was the weakest in almost four years. Monthly additions had averaged over 190,000 jobs for the prior 12 months—so we can likely blame two hurricanes and strike activity for what appears to be an aberration. The surveys, which operate much like a poll, had a depressed response rate, and these results may be revised in subsequent reporting periods. Job openings are roughly balanced with the number of unemployed persons; openings had been double the number of the unemployed in early 2022. Inflation in the cost of employment is coming down, and the increase in the employment cost index has come down to 3.9% from a high of over 5% in late 2022. Wages and salaries were up 3.7%, and the cost of benefits was up 3.9%. Overall, the employment picture is supportive of the “soft landing” outlook for the US economy and indicative of a lower inflation rate.
Inflation
- Inflation rose slightly in October
- “All items” CPI came in at 2.6%
- Core CPI was at 3.3%
- Inflation looking a little stuck
October inflation came in at 2.6% after hitting 2.4% in September, as measured by the “all items” CPI. Core inflation (less food and energy) came in at 3.3%. Energy was unchanged after declining 1.9% in September. Declining energy costs have been an important factor in slowing inflation over the past year. Food away from home (restaurants) contributed to higher prices in October, as did transportation services and medical care. Inflation does look a little stuck at this level and remains above the Fed’s target rate of 2%, but we should be cautious attaching too much importance to one month’s results. If progress on inflation does stall, it will impact the Fed’s approach to rates. Such an outcome could slow or even stop progress on lowering interest rates in 2025.
Interest Rates
- Overnight rate cut again to 4.75%
- 10-year rate jumps to 4.43%
The Federal Reserve’s Open Market Committee met on November 6 and 7. At that meeting, they cut their target for overnight interest by 0.25%. The target for that rate is now 4.50–4.75%. The overnight rate peaked earlier this year at 5.25–5.50%. The Fed is still widely expected to cut rates again by 0.25% in December. However, a stronger-than-expected economy and sticky inflation are starting to cloud that forecast, if only slightly. Furthermore, stated policy changes from the incoming administration, some of which could prove inflationary, may slow the expected future pace of rate cuts in 2025.
The 10-year Treasury, which is a much more important benchmark for widely used loans and mortgages, recently jumped to 4.43%, up from 3.63% in mid-September. This increase in rates, which was not the product of any action by the Fed, probably reflects the bond market’s ongoing concerns regarding the future course of inflation as well as ongoing borrowing by the federal government to fund its ballooning deficits. The result of lower short-term rates and higher longer-term rates has brought an end to the longest-lasting inverted yield curve in our history. An inverted yield curve, where short-term interest rates are higher than longer-term interest rates, is not a normal condition and has been historically viewed as a precursor to a recession. That has not proven true this time around, so far. A positively sloped yield curve, where long-term rates are higher than short-term rates, is a more normal condition and one that should favor investors and financial institutions.
Markets
- Dow and S&P surge following Trump’s victory
- Bond market mixed, short rates down, long rates up
The stock market staged a most impressive rally following Donald Trump’s election win. The S&P 500 rose above 6,000 for the first time, and the Dow surpassed 44,000. The rally was motivated by the very normal relief from the uncertainty of the election when it became evident that the result would be clear and decisive. It was also motivated by an expected return to a more “laissez-faire” regulatory environment and the possibility of a lower corporate tax rate. Much of that rally has since faded as the realization that stocks have hit historically high valuations and perhaps also with the realization that some of the announced policy changes could prove to be inflationary. Stock investors seem poised to celebrate, but stock valuations are high enough to limit the potential for future gains unless improving earnings give them another leg up.
Bonds are going through a difficult adjustment to lower yields on the short end and higher yields on the 10-year Treasury. Bond valuations move in the opposite direction of yields, and longer bonds are more sensitive to those changes than short bonds. Both moves together have ended the longest period in US history with an inverted yield curve. A positive slope to the yield curve is something of a return to normalcy, but the bond market will need confidence on two topics before the crucial 10-year Treasury rate comes down. First, it will need to be clear that inflation has returned to a sustainably lower level, and second, it will need some reassurance that progress is being made to reduce our federal deficit.
Investors have enjoyed a wonderful year of strong returns on both stocks and bonds. The S&P 500 is up 30.22% over the last year and up 23.78% year-to-date. After two years of miserable returns in bonds, an index of intermediate bond ETFs returned 10.57% over the past year and 2.18% year-to-date.
If we can help you navigate this changing business climate, please do not hesitate to contact your United Community Banker. Thank you for your readership, and best wishes for a wonderful holiday season.
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This information is for informational purposes only and does not constitute investment advice.
Sources:
GDP – Bureau of Economic Analysis
Employment & Inflation – Bureau of Labor Statistics
Interest Rates – Federal Reserve
P/E S&P 500 – multpl.com
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