The third quarter saw continued strength in financial asset returns, as economic data continued to show stable employment and gross domestic product growth amidst a slow, steady decline in reported inflation. By quarter’s end the Federal Reserve bank, believing they had made sufficient progress toward their desired economic “soft landing”, lowered the federal funds rate target by half a percent to a range of 4.75% to 5%.
While the interest rate futures market and many Wall Street analysts currently anticipate two more interest rate cuts before year end, there are several reasons we think this might be overly optimistic. First, the economic growth and employment data remain quite strong, calling into question the need for more cuts. Of note is that U.S. Treasury yields have drifted slightly higher since the September rate cut announcement.
Another issue calling further rate cuts into question is the impact of rising labor and energy costs on inflation. The settlement of the International Longshoremen’s Association strike supports this concern. The agreement called for a 62% total wage hike over the next six years. At the same time, geopolitical turmoil in the Mideast has put upward pressure on oil prices. Absent meaningful product pricing increases, these rising costs will put pressure on operating and profit margins.
One final inflation concern is the ongoing dramatic growth in U.S Treasury debt issuance. The Federal deficit has nearly doubled since 2010, and nearly $1.5 trillion of new Federal debt has been issued in the past two months. As the election draws near, neither party has come close to presenting a balanced budget, so we expect the accelerated growth of the Federal debt will continue regardless of the election outcome.
Based on current polling the election is too close to call across the board. Depending on the election results, corporate and personal tax rates, along with estate tax exemption levels could change dramatically. It is unlikely that there will be substantive tax code changes unless one party ends up in control of the executive and both legislative branches, and we expect to see market volatility as election outcomes are resolved.
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