A Peak Behind the Red Oak Curtain: Federal Reserve and Trump Administration Policy Analysis

Written By Aaron Tyburski, WMCP

Below is an internal email sent from Aaron Tyburski to members of the Red Oak Financial Group Investment Committee on 11/7/2024:

Today, the Federal Open Market Committee (FOMC) will likely elect to reduce the Federal Funds Rate (FFR) by a further 0.25% to a target range of 4.50%-4.75%. This decision will come on the heels of the September 0.50% cut that has triggered fears of sticky and/or accelerating inflation. Since the September meeting, the FOMC policymakers have had to digest a strong September Non-Farm Payrolls report, more robust than expected Gross Domestic Product and Gross Domestic Income data, strengthening Consumer Spending figures, firming Personal Consumption Expenditure Deflators, a weaker than expected October Non-Farm Payrolls report, a flagging Institute for Supply Management Manufacturing Purchasing Managers Index, a firming Institute for Supply Management Services Purchasing Managers Index, and a decisive Republican sweep of the White House, Senate, and House of Representatives.

Moving forward, I think it will be difficult for the FOMC to message how US monetary policy should evolve from this point. Recall that per the September Summary of Economic Projections (a quarterly forecast provided by the Federal Reserve) the Fed intends to reduce the risk-free interest rate gradually to their projected "neutral" level of ~3% (2.88% to be exact). That number feels uncomfortably low, with the 10-Year US Treasury Bond yield having backed up 0.82% since its trough on 9/16 (two days prior to the aforementioned 0.50% cut), and in view of the Trump administration policy proposals outlined below.

This we do know: the Federal Reserve has always taken fiscal policy at face value, meaning they do not make assumptions about the evolving fiscal trajectory when setting policy. That means the Fed is unlikely to materially alter the path of projected interest rate reductions based on the outcome of the general election. However, the Fed's outlook for fiscal policy should change, given that the Republican sweep scenario was well known to lead to the maximum degree of federal budget deficit expansion (as it did after President Trump was elected in 2016). Per 42Macro: "Our analysis definitively concludes the Republican Party has been the party of profligate debt growth in the postwar US economy, with seven of the top nine fastest growth rates of public debt coming via Republican administrations. Seven of the top nine!"

The possibility of Trump administration tariffs on foreign made goods has also caused inflationary concerns among investors (as is evident in rising 10-Year US Treasury Bond break even rates). However, historically the Fed has viewed tariffs as one-off changes to the general price level, and thus not something that warrants a monetary policy response (via a higher risk-free rate).

Additionally, border policy tightening and/or mass deportations should cause more salient concerns among members of the FOMC, with respect to future interest rate decisions. Per 42Macro: "Recall that the influx of labor supply represented a positive supply shock that allowed the US economy to grow at an above-trend pace at/near maximum employment with decelerating wage growth. We cannot stress enough how different the US economy and corporate earnings will perform if/when the positive supply shock ends or evolves into a negative supply shock. Stagflation is the hardest scenario to risk manage from the prospective of the Fed and investors alike."

In sum, the FOMC is likely to maintain its asymmetrically dovish reaction function well into 2025 - until the Republican policy agenda begins to impact realized US inflation and labor market data. This will likely result in FOMC policy being well behind the inflation curve come mid-2025.

Aaron

Aaron Tyburski, WMCP

At Red Oak Financial, we believe in low-cost, low-turnover, diversified, goals-based investing, and take a team approach to asset allocation. As head of our Investment Committee, I regularly present updates on current and forecasted economic trends and a range of probability weighted asset market implications. Chris and Bob have been intentional about cultivating a group of process-focused free-thinking advisors that each bring a unique perspective to the Investment Committee. Although varied our approach, we all strive to act in a way that emphasizes the importance of client outcomes while respecting the uncertainty that is inherent in markets.

Analyzing trends in economic data, risk managing investment portfolios, and disseminating timely market, economic, and behavioral finance-based commentary to our clients and team are my top priorities. In doing so I work closely with our Certified Financial Planners to build low-cost diversified asset allocations that are tailored to the needs and desires of our clients.

I grew up in Upstate New York, the middle of three brothers. Despite my father’s best efforts to turn me into an engineer, I preferred stock charts to heat transfer diagrams. I graduated in 2015 from the University of Albany, SUNY with a Bachelor’s in Business Administration, with focuses in Finance and Business Management, and a minor in Psychology. Post-graduation, I worked as a Financial Analyst at a large manufacturer, and then at a premier financial institution in New York. I moved to Baltimore in search of a new opportunity for growth and am enjoying the intellectual challenge of asset management more than ever.

Next

Understanding Equities: Economic Cycles and Equity Performance