The Future Is Uncertain

Strap in, we have a wide-ranging update on happenings all around the world that affect the economy, markets, and politics.

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Let’s Get Into It

If you’ve been paying attention to the world these days, things seem less predictable than ever. Will the Federal Reserve cut rates this year? Will the slow down in housing sales lead to lower prices? Who will win the majority in the House and Senate? Who will be the next president? Who will win the NBA championship? Anthony Edwards or Luka Doncic? Jason Tatum or is Tyrese Haliburton ready to become one of the NBA’s brightest stars? Arguably the answer to all these questions seem equally opaque.

This is not a sports newsletter, though the markets can seem as much of a game as the players running up and down the hardwood.

Even if we can’t predict the future, we can map out a few scenarios to help you digest what the Fed might do at the end of the year.

The Scenarios

Inflation Remains High

Don’t expect cuts if inflation remains high. We’ve mentioned it before, but no Fed Chair—including Jerome Powell—wants to be known as another Arthur Burns. For a refresher, Fed Chair Burns was in charge in the 1970s during a period of stagflation. Burns made a crucial mistake early in his tenure by lowering rates when inflation was already elevated. Inflation remained high and growth stagnant through the 1970s and was only fixed by a dramatic increase in rates by the next Fed Chair, Paul Volcker, into the 1980s. With this piece of history in mind, Fed Chair Powell is most likely well aware of just how dangerous lowering rates too early could be. If inflation remains high, expect no rate cuts this year.

Inflation Drops Noticeably

If inflation drops noticeably over the next couple months, then one to two rate cuts are possible. In fact, markets are currently predicting a September rate cut as 60% likely, as well as an additional December rate cut at 50%. While the economy is growing at a strong pace, there is evidence that lower income households are increasingly under pressure. Credit card default rates are ticking up (though not nearly at levels reminiscent of the past 10 year average).

Even with the pressure on lower income households, high income households drive most of spending. Higher income household’s are better able to cope with inflation thanks to locking in lower rate fixed mortgages which keeps their housing costs down, and with stocks at all time highs many high earners (or those with sizable investment accounts) are able to draw income from their investments. The bottom line is it’s very unlikely we’ll see a steep drop off in inflation through the back half of the year.

Inflation Increases Slightly

If inflation rises, it would be clear the current policy isn’t actually restrictive and the Fed will have to raise rates. The dangerous part here is that a rise an interest rates can do two things:

• Stock prices fall as investors become more fearful that inflation is sticky and won’t decrease.

• More businesses go bankrupt as they are unable to borrow at rates they can afford.

The Fed will also lose credibility, meaning that people no longer believe in the Fed’s ability to fight inflation and the idea that the Fed’s forward guidance matters at all. This could lead to more market volatility as traders and retail investors buy and sell stocks hoping that their own prediction on the markets are correct.

To the Victors Go the Spoils

If you haven’t noticed, it’s an election year—pretty much everywhere. There are more than a billion potential voters this year in elections across the world. The United Kingdom will be holding a vote on July 4th (potentially setting the stage for the second largest disappointment in that country’s history 🇺🇸). The world’s largest country and largest democracy, India, is holding elections right now. Other countries holding elections include Pakistan, Ghana, Mexico, South Korea, Lithuania, Finland, Belgium, Austria, and many many more.

Though elections in other countries may seem far away and unimportant, remember that they do have an impact here. For example, elections in India could lead to the continued leadership of Narendra Modi, who increasingly moved the country to a more independent leadership role in the world. This could lead to more construction across India’s largest cities as the country hopes to modernize, as well as continued foreign policy boldness which has shown up in successful and unsuccessful assassination attempts against Indians living abroad in Canada and the United States. In Mexico, a new president could lead to more immigration cooperation at the border, along with deals to encourage American companies to move manufacturing away from China and into Mexico.

But let’s be honest, everyone that reads this newsletter probably cares about what happens right here in the USA 🇺🇸. However, we’ll skip over the Presidential contest, and focus on the House and Senate. Right now, Republicans are favored to take the Senate, narrowly. The House is a little more contested—things largely look like a toss up.

Why is this important? Expect much of the green initiatives and more infrastructure spending to slow down under a Republican controlled government. Instead, Republicans may shore up legislation on the border (though don’t count on it), or maybe a focus on renewing the Trump tax cuts from 2017, which are set to expire in 2025.

Despite all the talk on the national level, know that local elections are most important. Your city, county, and state government has a larger impact then any federal legislation, so it (literally) pays to stay up to date on your local elections.

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