Changing of the guard
Most of the market participants’ attention has been directed toward Trump’s first week in office, especially pertaining to tariff discussions. No change in the fed funds rate is expected at this week’s Fed meeting. Credit spreads continued their fall last year, indicating an ongoing uptick in optimism toward the economy among market participants. While spreads have been performing better, investors remain cautious.
Attention is understandably focused on the changing of the guard in Washington and the eagerly anticipated policy details from the new administration which will heavily influence the economic performance over the coming years. On that point, Trump signed a litany of executive orders and memorandums his first day in office spanning a number of areas, including immigration, energy, and foreign policy. On the energy front, President Trump declared a national energy emergency and signed executive orders that will, among other things, review burdens to energy development and end the freeze on the approval of new liquid natural gas export permit applications.
Furthermore, President Trump made comments regarding his intentions to refill the Strategic Petroleum Reserve. While these actions are seen as bullish and an attempt to spark animal spirits in the sector, questions remain as to whether the desired surge in private sector investment and output will unfold if oil prices fall materially lower over the coming years.
While executive orders on trade tariffs were notably absent, President Trump initially alluded to the possibility of a 25% tariff on imports from Canada and Mexico starting as soon as February 1. Subsequent comments later in the week were less hawkish, considering 10% tariffs on imports from China, though highlight how much trade discussions remain in flux. Understandably, the administration is ironing out the details, including breadth, degree, and implementation. Consensus analyst base case is for a 5% universal tariff alongside a 30% tariff on imports from China. Until clear guidance is given, the uncertainty about tariffs and the impact on the economic outlook remains high, particularly for firms evaluating existing supply chains and for those considering new investments.
The Fed has cut rates at each of its past three meetings since September, amounting to a cumulative reduction of 100 bps. The upper bound of the target range now sits at 4.50%; however, a pause in the easing cycle seems likely at this week’s meeting and is widely expected by market participants. Economic growth has been strong entering 2025, and inflation has proved to be less cooperative than the Fed would like. Comments from many policymakers at the Fed have highlighted the risks to further policy accommodation with PCE inflation still sitting at 2.4% year-over-year and core PCE inflation running at 2.8%. While the risks to the inflation side of the Fed’s dual mandate have remained apparent, the risks to the employment mandate have subsided somewhat compared to a few months ago. The unemployment rate dropped a tenth to 4.1% in December, and nonfarm payroll growth has now been north of 200K in each of the past two months.
Looking forward, the Fed will likely remain on hold for the first half of the year, then looking for two cuts of 25 bps each during the September and December meetings, with the Fed holding its target range at 3.75%–4.00% throughout 2026.
Internationally, it is worth noting that the Bank of Japan (BoJ) delivered a 25 bps rate hike at its January meeting. The monetary tightening brought the BoJ policy rate to 0.50%, a level last seen in late 2008. This rate hike was mostly expected and priced by financial markets but is yet another signal that BoJ policymakers are increasingly comfortable moving away from ultra-accommodative monetary policy settings. While growth is still lackluster, CPI inflation has trended higher over the past few years. Higher inflation, sparked by higher wages, has been the impetus for multiple rounds of recent BoJ tightening. To that point on inflation, Japan also revealed that local policymakers expect inflation to pick up pace going forward as they adjusted their inflation forecasts notably higher. Supporting the BoJ’s view on inflation were CPI ex-fresh food data that showed prices firmed to 3.0% year-over-year. With inflation seemingly at more sustainable levels and the BoJ firmly in tightening mode, it is expected that policymakers to deliver additional tightening going forward.
The European Central Bank (ECB) announces its monetary policy decision this week, at which it is expected that the central bank will continue with its measured approach to monetary easing. The consensus expects the ECB to lower its Deposit Rate another 25 bps to 2.75%. Supporting the case for a further rate cut next week, several ECB policymakers have highlighted the sluggish growth dynamic of the Eurozone region and suggested inflation remains on course to reach to the 2% target later in 2025. Against that backdrop, policymakers have indicated market expectations that the ECB will lower interest rates at upcoming meetings appear plausible and reasonable. Growth risks that are arguably to the downside and a policy rate that is still above a neutral level are also arguments for further monetary easing.
All eyes are still on the U.S. and on Trump. What will happen with tariffs and what other economic plans does Trump consider. It is suddenly a new reality, and the world is paying attention.