Election Year: Fiscal Spending and Monetary Policy Heightens Volatility

By Veronica A. Fulton, CFA, Associate Portfolio Manager

Election years are typically characterized by volatility in financial markets, as investors generally don’t respond well to uncertainty. Speculation around the Fed rate path during this period will only exacerbate that. By now, most market participants are up to date on Fed Chair Powell’s views as it relates to monetary policy. For those who are not – the probability of a rate cut in March is highly unlikely. He is pleased with how much inflation has cooled, however before the committee starts to reduce the Federal Funds Rate, he needs confirmation that inflation is sustainably moving down to their 2% target. With an economy growing at 2.5% in 2023 and unemployment rates hovering at historical lows, we agree the Fed has some room to wait. Over the last two weeks, the market has been digesting Fed Chair Powell’s comments and, consequently, the odds of a rate cut in March have decreased to less than 20%.

As more rate cuts get priced out and market participants come to grips with higher for longer, more scrutiny surrounding national debt levels has emerged.  In 30 years, it is projected that the national level of debt in the US will exceed $144 trillion.  We’ve seen rhetoric from prominent market figures surrounding the unsustainable fiscal spending path the United States is on, as our country’s debt levels are growing faster than our economy. This directly impacts the creditworthiness of the US and ultimately the rate at which the government can continue to borrow and service existing debt. Essentially, high and rising deficits will continue to put secular upward pressure on Treasury supply and long-term yields.

Approaching the election, we expect to see some choppiness until consensus decides on the likely winner and then volatility settles out. However, regardless of which political party takes the oval office, it has become evident that the resulting fiscal policies will serve to increase rather than decrease the deficit. It’s been our belief that yields must go through a consolidation phase, and it will take some time to be confident in where they ultimately settle out, but the days of ZIRP are long gone. Just as equity markets and the economy have been forced to adjust to a higher rate environment, our political officials will have to do the same. We believe the bond market is sniffing this out, and the heightened volatility of yields as of late are about future fiscal spending more so than inflation.  We expect to see more focus on fiscal sustainability as a latter half theme, however at present all eyes are on the Fed’s rate path and the presidential election.

Sources: Bureau of Economic Analysis, Congressional Budget Office, CME Fed Watch, FactSet

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