US economics, inflation, and the Fed

Long-term Treasury yields perked up recently. This move higher comes despite the Federal Reserve reducing the federal funds rate by three-quarters of a percentage point this fall, to 4.50%-4.75%, and sentiment that it will likely cut by another 25 basis points at the final Federal Open Market Committee (FOMC) meeting in December 2024. In Value Line’s opinion, there are a few reasons for the recent steepening of the yield curve. This move indicates an expectation across financial markets of higher rates in the future. The October readings on consumer and producer (wholesale) price growth were a bit stronger than expected, bringing talks that the Fed may have to pause on the interest rate front at some point next year. There are also concerns that the pro-growth policies President-elect Trump will push to implement may ultimately lead to a reacceleration in inflationary pressures, especially if they include the increased use of trade tariffs.

Wall Street now forecasts interest rates will be higher than previously expected. Indeed, the low-point expectation of the 2026 federal funds rate, which was hovering around 2.90% earlier this year, has risen to 3.80%. The increased level of short-term rates typically results in a higher yield for 10-year Treasury notes according to Value Line. This sentiment took some of the steam out of the post-election equity market rally.

Meantime, the consumer sector will be on the radar of Wall Street in the coming weeks. That is because the all-important holiday shopping season for retailers is at hand. The consumer has proven resilient amid the increased borrowing-cost environment of the last few years, but the expected relief from the Federal Reserve cutting the benchmark short-term interest rate has yet to materialize. This may put some pressure on spending, especially with many Americans faced with maxed-out credit card balances. Likewise, with 30-year fixed-rate mortgages still averaging around 7.00%, housing affordability remains troublesome.

Nevertheless, the US economy overall is much less interest rate sensitive than it used to be – with most households locked in at historically very low mortgage rates and employment staying strong by historic measures. The consensus on US GDP is a 2.8% growth this year. The US business and stock market look very healthy too. Moreover, the technological breakthroughs and productivity increases from Artificial Intelligence are yet to propagate throughout businesses of all sizes and should be supportive of the profitability of US companies for years to come!

Global economy

JP Morgan (JPM) maintains a narrative based on growth resilience and sticky inflation that leaves limited room for policy rate normalization. However, this year’s developments have altered the bank’s thinking about the implications of a high-for-long rate environment. Foundational to JPM’s outlook, and unaltered for some time, is a view that sticky inflation will limit central banks’ room to ease. This view has not changed in their 2025 outlook. However, in contrast to the fear they flagged last year that high interest rates would eventually “boil the frog” and sow the seeds for an end to the global expansion, JPM turned more sympathetic over this year to scenarios in which the expansion is sustained despite high interest rates.

Key developments for the 2025 outlook include:

• The frog in the jacuzzi. Although JPM had pushed back against the consensus view for a 2023 recession, their global baseline scenario published in the year ahead 2024 outlook a year ago anticipated high interest rates to weigh on global expansion and threaten recession by late 2024 or early 2025. Contrary to this view, restrictive central bank stances were not enough to prevent a robust 5% gain in global nominal GDP this year that allowed profit margins to remain near historical peaks. Easing financial conditions complemented solid labor income and wealth gains, allowing household balance sheets to remain strong and supporting consumer spending. These conditions remain largely intact and provide support to withstand still-elevated rates. This high-for-long soft-landing scenario sees healthy, mid-cycle fundamentals having pushed up the short-run US neutral rate. This view also recognizes that policy rates are modestly tighter than standard Taylor rules would suggest, reinforcing an asymmetry in central bank reaction functions that makes them unlikely to tighten in the face of stronger growth or inflation and more likely to ease into weaker labor markets.
• Trump (wild) card: The heat may still turn up on JPM’s proverbial frog in the jacuzzi as a set of potential disruptive US policies become enacted early next year. The bank’s baseline assumes a full-blown trade war on China (with 60% tariffs on all imports) and a sharp slowing in immigration, with the former acting as an adverse supply shock on the global economy and the latter stymieing the past few years’ positive supply windfall in the US. In combination these will temper growth momentum while inflation pressures will rise. Hopes for US deregulations and FY2026 fiscal policies would provide a boost to US growth, but further fan inflation.
• Divergences take the cyclical driver’s seat. Perhaps the largest global development underway for 2025, beyond the uncertainties of US policies, is a shift from the powerful global impulses driving synchronization over the past four years toward local conditions that are producing divergent inflation and growth gaps that lead to varied policy paths. In the developed markets, the Fed and Bank of England are expected to end their easing with rates close to 4% (and perhaps even higher given the inflation and growth dynamics noted above) while the European Central Bank and Riksbank lower rates below 2% in response to a shift toward demand-side weakness. A large intra-EM (emerging markets) rate gap should show only marginal narrowing as high yield central banks face both domestic and global political constraints.

On balance, JPM expects a boost to demand from anticipated fiscal and regulatory policy in the US to more than offset the supply shock and have raised its 2025 GDP forecast by 0.4%-pt to a 2.2% increase for the year. Elsewhere, however, the revisions are downward. In China, the bank has lowered its GDP forecast 0.8%-pt to a 3.9% annual increase, despite additional fiscal stimulus and a yuan decline that tempers the negative trade shock. Although European growth should be boosted from US demand and dollar movements, these benefits are expected to be offset by weaker growth in Asia and a hit to sentiment. The wild card will be the impact on German businesses, which appear to have already turned more cautious. Overall, Europe looks to be nearing stall-speed at year-end. Overall, JPM forecasts the global GDP to advance by 2.7% this year and forecasts global expansion to continue at 2.4% in 2025 as well.

Stock market

Recently, Signet team rebalanced its main actively managed equity strategies albeit the rebalancing was very light.

We maintain our barbell approach combining promising cyclical and defensive stocks and over-emphasizing more profitable companies. It makes sense to keep exposure to Large Growers of a GARP (growth at reasonable price) nature (Technology, Communications, some Discretionary), which is the cohort of Large Growers outperforming their expensive peers. Their outperformance is justified by record profits and early adaptation of AI. Moreover, we like cyclicals at an attractive valuation level, and we find it appropriate to maintain a healthy exposure to Financials, Industrials and Technology. We have become more attracted to Real Estate as interest rates are relatively low. We have warmed up to some Utilities, since they will become beneficiaries from increased electricity consumption by data centers on the wave of cloud computing and AI. We maintain adequate exposure to Healthcare — the sector proved to be a great hedge in times of higher volatility. So, in a nutshell, as the market turns from an indiscriminative macro driven state to paying attention to individual company fundamentals (especially profitability and growth prospects), it pays to be more selective in each economic sector. (See Signet Proprietary Sector Forecast below).

Judging by the Macro Score composition, we should emphasize Growth but still have adequate exposure to Profitability. Value and Yield still play an important role going forward, keeping in mind a reduced probability of a recession next year. Safety is on the backburner for now.

Signet Macro Score 1 Yr Composition:

This heatmap represents the weights of factor groups in Signet’s Macro Score.

Signet Sector Consensus 12-month forecast:

In our forecast we take into consideration the macro-economic situation and fundamental attractiveness of economic sectors.

The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results. The information sources used in this letter are: WSJ.com, Jeremy Siegel, Ph.D. (Jeremysiegel.com), Goldman Sachs, J.P. Morgan, Empirical Research Partners, Value Line, BlackRock, Ned Davis Research, First Trust, Citi research, HSBC, and Nuveen.

IMPORTANT DISCLOSURE

Past performance may not be indicative of future results.

Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that their future performance will be profitable, equal to any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.

The statements made in this newsletter are, to the best of our ability and knowledge, accurate as of the date they were originally made. But due to various factors, including changing market conditions and/or applicable laws, the content may in the future no longer be reflective of current opinions or positions.

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