It was another quiet holiday-shortened week for the markets, but a new year brings a fresh outlook. January alone is going to bring the inauguration (or re-inauguration) of a new president and the U.S. government is likely to hit the debt ceiling. Both events could create more volatility for the markets.
A second Trump presidential term will bring with it promises of tax cuts for corporations and high net worth individuals and the potential for significant tariffs on foreign imports. The former could be a tailwind for U.S. equities, as it was following the passage of the Tax Cuts & Jobs Act during Trump’s first term, but the second has the potential to cause some damage. While the latter could create a revenue source for the government and the reshoring of U.S. business, they are ultimately an inflationary cost increase for consumers. If Trump’s threats of 10-25% tariffs on many country’s imports come to pass, it could hit the brakes on a global economy that’s already struggling to grow in many non-U.S. regions of the world.
Don’t be surprised if inflation quickly becomes a larger theme in the new year. We’re already seeing modest accelerations in the United States, Europe, Japan and elsewhere. While these may ultimately prove to be short-term in nature, current macro forces, increased global liquidity and the threat of a more challenging global trade environment are all supportive of the idea that higher inflation could be here to stay. Powell already indicated that the Fed is concerned about rising prices in his latest press conference and that was reflected in the Fed Dot Plot. The market is only pricing in 1-2 rate cuts this year and may be unable to provide much monetary support if inflation remains elevated.
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We may be seeing risks starting to get priced into the bond market as well. High yield credit spreads have been expanding for three weeks and, while that’s not enough to suggest that there’s stress in the system yet, it is a sign that bond investors might finally be turning a little more cautious on conditions. Long-term Treasury yields are near their highest levels of the past year, a result of less anticipated Fed action and the increased likelihood of higher inflation.
In the United States, GDP growth is still healthy and the labor market is still tight. They could still drive risk asset prices higher, but there are a lot of variables that could throw a wrench in the engine.
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