Inside Markets — Uncertainty

The financial press continues to refer to tariffs as inflationary, which isn’t technically correct.  Assuming it doesn’t reoccur, a tariff is just a price adjustment that can translate to a temporary increase in inflation.  And while there’s still a lot of uncertainty, we also doubt the incoming administration will pursue a broad set of inflationary policies.  Whether it was pursed or not, the outgoing administration encouraged inflation through a massive increase in fiscal spending when supply remained constrained due to the pandemic.  The economics team from Trump’s first term were mostly supply-side economists with the current list of front-runners for Treasury Secretary and other economic positions fitting that mold.  Supply-side economists would likely endorse increased supply to cure sticky inflation – and one of the reasons to expect lower energy prices in the future.

We expect the Fed will end up cutting rates in December to 4.375% with the updated dot plot showing higher rate expectations further out on the curve (raise the longer run dot). We also expect the ’25 median dot to imply 50bp of cuts next year vs. 100bp currently.  At the moment, Fed officials sound like they will pause at the January meeting as they shift more toward data dependency.  This new phase will likely introduce more rates volatility and possibly more equity market volatility.

Elevated levels of implied equity volatility (VIX >22) is the number one near-term risk for equity markets.  Higher levels of equity volatility tend to follow more volatile rates/bond markets.  In the current environment, a short-term move in 10-year yields above 4.60% would likely result in a VIX>22.