Could election uncertainty delay interest rate cuts? ~ Credit Sesame

Credit Sesame discusses how the upcoming election could influence and delay interest rate cuts.

Federal Reserve Chair Jerome Powell recently expressed cautious optimism that inflation was easing. Bond market investors did not find his optimism contagious.

The impending presidential election may be a complicating factor. Big elections create uncertainty, which investors generally dislike. In addition to not knowing who will be leading the country in a year’s time, there are also specific reasons why this election may disrupt the long-anticipated return of lower interest rates.

Fed Chair is optimistic, but the bond market is not

In a recent speech Powell said he was optimistic that inflation was easing. Recent trends in the Personal Consumption Expenditures (PCE) price index support his optimism. May 2024 saw monthly and year-over-year declines in both the overall and core inflation rates.

Normally, the Fed Chair’s optimistic statements about inflation, combined with fresh evidence of slowing inflation, would support a rally in the bond market. Rising bond prices go hand in hand with falling interest rates. However, the recent bond trend has been towards falling prices and rising yields.

The timing of the bond slump coincides with the first presidential debate. President Joe Biden’s poor showing in that debate appears to have increased Donald Trump’s chances of winning the November election. Among bond investors, that prospect seems to have stoked inflation concerns.

Why do bond investors view Trump as an inflation threat?

Bond investors are very skittish about inflation. They react to any possible signs of inflation like a germaphobe does to an elevator full of coughing people, or a long-tailed cat to a room full of rocking chairs. In short, they head for the exit.

Bonds represent a promise of future payouts. People buy bonds based on the value of the interest the bond pays over its lifetime plus the principal paid out when the bond matures. Inflation erodes the value of those future payouts, meaning you will be able to buy less. This makes it worth less today.

Bond investors think a Trump victory in November 2024 could lead to more inflation. The assumption seems partially based on his track record and partially based on his current campaign promises. During his presidency, Trump withdrew from trade agreements and imposed tariffs. He has promised more tariffs if elected to a new term as president.

While tariffs are positioned as penalties on foreign manufacturers, they are effectively a tax on domestic consumers. Tariffs raise the prices that consumers pay for imports. Also, by raising the prices of imported goods, tariffs give domestic manufacturers more pricing power. So, whether you buy American or not, tariffs inflate the prices you pay.

The likely inflationary characteristic of a second Trump presidency has been cited as a reason that bond prices fell and interest rates rose after Biden dithered in the recent debate.

Trump and Biden have inflationary tendencies

If there is one thing that unites Trump and Biden, it’s their inflationary tendencies. Both have pursued similar policies that have contributed to inflation in the past or may do so in the future:

• During the pandemic, both Trump and then Biden sent stimulus checks to most Americans, regardless of whether their incomes had actually been affected by lockdowns. Providing this excess stimulus at a time when the availability of goods and labor was constrained by the pandemic lit the fuse for the inflation that blew up shortly thereafter.
• Both use tariffs to protect American companies in a few select industries. The tariffs benefit those manufacturers at the expense of consumers, resulting in higher prices.
• Failure to constructively address immigration is another thing both of this year’s candidates have in common. Turning a blind eye to massive illegal immigration isn’t the answer, but neither is slamming the door on would-be immigrants. The U.S. Chamber of Commerce has cited the decline in legal immigration as a reason for labor shortages, which has helped fuel inflation. The Chamber notes that accepting fewer immigrants is especially harmful at a time when US demographics feature an aging workforce with huge numbers of people retiring.

The recent debate seems to have focused the bond market on the inflationary implications of a second Trump presidency. However, both candidate’s records reinforce how difficult it will be to subdue inflation in today’s political environment.

What does this mean for the 2024 inflation outlook?

When this year began, financial markets and economists generally expected multiple rate cuts in 2024. The Federal Reserve’s economic projections reinforced this view.

At the end of 2023, the Fed expected the equivalent of roughly three 25-basis-point rate cuts in 2024. However, the most updated projections, issued just last month, show the Fed now expects only about one 25-basis-point rate cut this year. Powell’s recent comments suggest that won’t happen in their late July 2024 meeting. Since the Fed strives to be politically neutral, it might shy away from making a rate cut in the run-up to the election.

That would leave just two meetings for the Fed to cut rates after the election. If there is a rate cut in 2024, it may be quite late in the year.

In addition, bond market activity shows that inflation concerns might keep some interest rates high regardless of what the Fed does. Neither candidate is likely to help with those concerns.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.