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WEEK AHEAD
December 23-27, 2024
Better trending Core PCE prices weren’t enough to offset the pullback from the Fed’s surprise revised interest rate outlook. Despite the brief market decline, our tactical models remain balanced and fully invested for the time being.
The Federal Reserve, in a widely anticipated move, trimmed its benchmark interest rate by 25 basis points to 4.5% on December 18. While the gesture was framed as a response to cooling inflationary pressures, the Fed dampened any budding market exuberance by signaling a more conservative trajectory for rate cuts in 2025. Investors, seemingly caught off guard by the Fed's cautious tone, recalibrated their expectations, triggering a broad retreat in equities and bonds.
The S&P 500 shed 1.97% for the week, with interest-sensitive sectors bearing the brunt of the downturn. Industrials plummeted 3.83%, basic materials fell 4.84%, energy slid 5.54%, and real estate dropped 4.74%. The rise in bond yields exerted acute pressure on these capital-intensive sectors, raising questions about their ability to navigate an environment of elevated borrowing costs.
The bond market offered little respite. The 10-year Treasury yield climbed from 4.4% to 4.52%, while the 30-year yield surged to 4.72%, its highest level in years. The broader bond market dipped 0.69% for the week as investors grappled with the implications of higher long-term yields, which suggest persistent inflation expectations or waning demand for government debt.
Economic data, meanwhile, painted a mixed picture. Industrial production disappointed with a contraction of 0.9% in November, far below the consensus forecast of a 0.1% increase. Yet, the economy's broader momentum appeared intact, with annualized GDP growth accelerating to a robust 3.1%, outpacing prior estimates. Inflation, too, showed signs of moderation, with the core Personal Consumption Expenditures (PCE) index—widely regarded as the Fed’sFed's preferred inflation gauge—rising 2.8% year-over-year.
While economic growth remains resilient, the interplay between rising yields and softer industrial activity suggests the economy may be transitioning into a slower, more uneven phase of recovery. Investors, meanwhile, seem caught between relief over easing inflation and apprehension about higher-for-longer borrowing costs. This tug-of-war will likely dominate market dynamics as we head into 2025.
As we approach the Christmas holidays and a shortened trading week, market activity is expected to lighten, with limited earnings reports on the docket. Yet, the pulse of Wall Street will remain firmly attuned to the state of the economy. Key economic indicators—Durable Goods Orders, New Home Sales, and Jobless Claims—will take center stage, offering crucial insights into the resilience of consumer demand, the housing market, and the labor force.
"I think that the lower, the slower pace of cuts for next year really reflects both the higher inflation readings we've had this year, and the expectation inflation will be higher. You saw in the SEP that risks and uncertainty around inflation, we see as higher. Nonetheless, we see ourselves as still on track to continue to cut." – Federal Reserve Chair Jerome Powell FOMC Press Conference, December 18, 2024
History of the President and the Fed
President Trump has expressed his belief that the Fed is keeping interest rates at elevated levels that are not consistent with acceptable economic growth. President Trump's criticism of the Fed has stimulated hand-wringing on the part of investors and pundits and speculation about the eventual consequences of any significant conflict arising from differences between The President Elect's vision of optimal Fed policy and the policies favored by the Fed's Board of Governors. Those who see a unique drama unfolding should be aware that conflicts between Presidents and the Fed centered on economic policy are not unusual, the Fed is not truly an independent entity, and the Fed has not been adept when pursuing its mission.
The First Bank of the US was established in 1791. It was controversial before it became a reality. Thomas Jefferson opposed the establishment of the Bank, stating it was unconstitutional and a powerful monopoly that would further the interests of rich urban industrialists at the expense of farmers and those who lived in rural areas of the country. Alexander Hamilton favored the Bank while arguing it was necessary to manage the debt the new nation incurred throughout the Revolution. George Washington favored Hamilton's position, and the bank was founded.
The Bank was given a life of twenty years and required legislation to continue beyond that horizon. President Andrew Jackson opposed the bank because, like Jefferson, he thought it was too powerful and would favor wealthy industrialists. Jackson's conflict with the Bank came to be known as the Bank War. In 1832, he vetoed the legislation required for the bank to continue. For the remainder of the nineteenth century, there was no central bank.
In 1913, the Fed was established by an act of Congress, with President Wilson's signature. The stated motivation for creating the Fed was to establish an entity to oversee banks in the US and prevent bank panics like that of 1893. The events of 1929 and soon after demonstrated that the Fed could not prevent bank panics or manage monetary policy in a manner that was consistent with adequate economic growth. Nevertheless, Congress enacted the Banking Act of 1935, which solidified the Fed's control of the banking system and granted the Fed control of monetary policy. In addition, it changed the name of the Federal Reserve Board to the Board of Governors of the Federal Reserve System and made other changes to the board's structure. The Board Chair serves a four-year term and is nominated by the President and confirmed by the Senate.
While the President cannot remove the Fed Chairman, he can provide a reason for him to resign. In 1951, President Truman stated with respect to fed Chairman McCabe, "his services were no longer satisfactory." McCabe then resigned. President Truman's public criticism of the Fed's policies arose when he wanted the Fed to finance the Federal budget deficit driven by spending to fund expenses related to the Korean War. In contrast, the Fed wanted to "peg" interest rates. The contretemps led eventually to the Treasury-Fed Accord of 1951. The Accord relieved the Fed of the obligation to be the lender of last resort for the Treasury.
President Carter nominated G. William Miller to be Fed Chairman in 1977. Miller was confirmed by the Senate but resigned in 1978 to become Secretary of the Treasury after Michael Blumenthal left that position. Miller's performance as Fed Chairman was the object of relentless criticism as inflation increased and economic activity slowed. His move to his new position was either fortuitous or resulted from political consequences for Carter as he defended Miller.
While the Chairman Miller drama unfolded in 1978, Congress decided to weigh in with legislation establishing goals and objectives for the Fed. Congress passed, and President Carter signed the Full Employment and Balanced Growth Act, also known as the Humphrey Hawkins Act, which amended the Employment Act of 1946. The Act requires the Fed to achieve an unemployment rate of 3% or less for those twenty or older and inflation of less than 3%. The Fed was directed to achieve these goals within five years. The Act included the expectation that inflation would be 0% by 1988.
Congress has not hesitated to remind the Fed that it exists within a political reality. As evidence of that reality, the Fed Chairman is required to testify to Congress twice per year on monetary policy. This testimony is often great theater. Members of Congress can appear to be riding hard on the Fed, and the Fed can appear concerned about whatever concerns Congress, be it inflation, unemployment, or any other irritating economic condition, but neither participant offers up actionable policies.
Paul Volker succeeded William Miller as Fed Chairman in 1978. At that time, the nation was sliding into high inflation, approaching 13% annually, accompanied by 10% unemployment. The good intentions manifested in the Humphrey Hawkins Act were not a road map for economic prosperity. Inflation and unemployment rose, and Carter suffered the consequences when he lost the 1980 election to Ronald Reagan.
President Reagan and Chairman Volker agreed to a plan to reduce inflation and generate positive and robust economic growth. Volker eventually raised the Fed funds rate to 20%, and President Reagan gained bi-partisan support for major cuts in tax rates. The short-term economic consequences of these policies were first a recession and then rapid economic growth and falling inflation. Chairman Volker would have likely been under significant pressure to resign had President Reagan challenged the Fed's policies.
Chairman Volker was the first Fed Chairman to vigorously fight inflation since 1971 when President Nixon closed the gold window. At the time the window closed, the official price of gold was $35 per ounce. Currently, the price is over $2,600 per ounce.
Since 1913, the Fed has presided over a major economic depression, numerous recessions, and a rapid decline in the value of the dollar. Members of Congress and Presidents have often criticized its activities. The Fed's independence is conditional; if elected officials are not happy with economic conditions that threaten their election or re-election, then the Fed's independence will be challenged. President Trump is reminding the Fed of what has been obvious since 1913, the Fed will be the object of criticism should economic conditions not be satisfactory.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.