Back in the saddle — Cue Aerosmith’s “Rocks” album on the turntable (or on Spotify, for the digitally inclined). Rocks feels like an appropriate motif to start 2025: We see increased volatility in stocks, rapidly rising interest rates and, of course, a much higher volume of updates from the incoming Executive Branch of the United States.
Perhaps the biggest theme entering 2025 is the return of Donald Trump to the White House. His anticipated policies will be pro-business, pro-growth, pro-stock market, and, possibly, pro-inflation. In recent weeks, we have been reminded that impromptu tweets and press conferences, filled with streams of consciousness, will become the new norm—and with it, higher volatility is likely to return.
The 2025 base case outlook for many economists supports a modest global economic expansion, with the U.S. leading the way. With the latter’s rosy outlook for growth, the need for rate cuts has declined as well. Indeed, President-elect Trump’s potentially inflationary policy (tax cuts without spending restraint) may limit or erase the Federal Reserve’s ability to deliver additional cuts.
Below are a few excerpts from Wall Street prognosticators to provide additional context on the economic forecast for America this year:
- Bank of America economists anticipate a goldilocks scenario for global growth (3.25% GDP growth with 2.5% inflation), along with another year of monetary easing and increasing budget deficits.
- JPMorgan Chase is positive on American assets in a world where “US exceptionalism gets reinforced, amidst a prolonged business cycle.”
- Ned Davis Research believes “The skies appear mostly clear for financial markets heading into 2025. The Fed’s easing cycle is ongoing amid disinflation and low recession risks, earnings growth is solid, and the rally is broadening.”
- Neuberger Berman expects “A year of above-trend growth. While the politics may change, industrial policy aimed at influencing domestic production patterns will continue, whether achieved via government spending and investment, tax policy, trade policy, deregulation or other means. If inflation can be contained — and we think it can — central banks can stand aside and allow economies to run a little warm. That is a recipe for above-trend U.S. GDP growth, which could drag some of the world’s other economies with it.”
- David Mericle of Goldman Sachs wrote: “We see the same simple story for solid (+2.3%) consumer spending growth in 2025 as in 2023 and 2024. A healthy labor market should keep real income growing at a 2.5% pace across the income distribution this year, and this should be the main driver of spending growth. Wealth effects should provide a modest additional boost because household finances are in strong shape and have strengthened further on the back of steady increases in equity prices, which tend to support consumer spending gradually over a few quarters.”
While economic fundamentals are certainly affected by fiscal policy, we would argue that it is monetary policy that holds the true burden of balancing growth and inflation. The year ahead will therefore test the Fed’s resolve in delivering further rate cuts, given the crosscurrents of risks on the macro horizon. To expand on Mericle’s comments above, the U.S. consumer has allowed the Fed the flexibility to maintain high interest rates without tipping the economy into recession. Friday’s labor report emphasized this point.
The Bureau of Labor Statistics tallied an increase of 256,000 non-farm jobs added in December, topping nearly all economists’ forecasts. The robust jobs report won’t change monetary policy in the near term, however. Federal Open Market Committee (FOMC) members have already telegraphed a pause for the upcoming January meeting, but the employment figures may support further caution in reducing rates thereafter.
“Worries about the risk of a sharp deterioration in labor-market conditions back in September — when the Fed started cutting rates — have more or less evaporated, and it seems pretty certain that the pace of Fed rate cuts is now going to slow down,” Brian Coulton, chief economist at Fitch Ratings, wrote in a note after the report. In fact, per federal funds rate futures, the odds of a rate cut of 25 basis points (bps) at any FOMC meeting in 2025 was no greater than 31% as of Friday afternoon.
Meet the class — The changing makeup at the Fed also gives us reason to believe that pauses may be more likely in the year ahead. The voting members of the 2025 FOMC changed as we rung in the new year. While all 19 top-level officials participate in the meetings, only 12 get to vote: seven Fed governors, four of 11 regional bank presidents on rotation, and the New York Fed president.
Richmond’s Thomas Barkin, Atlanta’s Raphael Bostic, San Francisco’s Mary Daly, and Cleveland’s Beth Hammack will rotate off the voting list in 2025. (Hammack, you may recall, was the lone dissenter at the final FOMC meeting of 2024, where she preferred no rate cut.) These four presidents will be replaced by Boston’s Susan Collins, Chicago’s Austan Goolsbee, St. Louis’ Alberto Musalem, and Kansas City’s Jeffrey Schmid.
Below are several excerpts from a recent Barron’s article summarizing the FOMC’s incoming voter class:
- “The new voters bring diverse backgrounds to the table. Collins and Goolsbee both have had accomplished careers in academic economics, with Goolsbee also serving as chairman of the Council of Economic Advisers during part of President Barack Obama’s term. Goolsbee has been among the more dovish FOMC members over the past year, advocating for rate cuts this fall and focusing on the progress made in slowing inflation over the past two years. Musalem has experience in the investment world, at firms including Tudor Investments and Evince Asset Management. Of the new voters, Schmid is most focused on banking issues. Prior to joining the Kansas City Fed, he led Mutual of Omaha Bank as its CEO and chairman. In addition to setting monetary policy, the Fed plays a role as a financial regulator. Philadelphia Fed President Patrick Harker is set to retire in June 2025, with a search process under way to identify a successor. The Philly Fed rotates into a voting seat in 2026.”
- “Among the new voters, Musalem and Schmid in particular have sounded more hawkish than their colleagues in recent remarks. ‘While now is the time to begin dialing back the restrictiveness of monetary policy, it remains to be seen how much further interest rates will decline or where they might eventually settle,’ Schmid said on Nov. 13.”
- “In early December, Musalem noted some concern about the last mile of the Fed’s inflation fight, noting it would be appropriate to slow the pace of interest-rate reductions in 2025. He added that it’s unlikely that rates will return anytime soon to the near-zero levels seen during most of the decade between the financial crisis and the Covid-19 pandemic.”
The following table illustrates the changing of the FOMC guard:
Last week, Federal Reserve Vice Chair for Supervision Michael Barr announced his intention to step down from his post, but will remain as a member of the Fed’s Board of Governors (his term expires in 2032). His last day as Vice Chair for Supervision will be February 28 unless a successor is confirmed earlier. “The position of Vice Chair for Supervision was created after the Global Financial Crisis to create greater responsibility, transparency and accountability for the Federal Reserve’s supervision and regulation of the financial system,” Barr said in a statement. “The risk of a dispute over the position could be a distraction from our mission.”
The controversy arose as President-elect Trump’s victory (with his preference for bank deregulation) put Barr (an opponent of deregulation) in the political crosshairs. Barr has been a key player in favor of proposals to force U.S. banks to hold significantly more capital as a buffer against losses and potential crises. The financial industry has reportedly lobbied aggressively against the latest round of new regulations, known as Basel IV, and bank stocks rallied strongly after Barr’s announcement to step down.
However, Barr’s decision to keep his seat as a regular member of the Fed’s Board of Governors means Trump won’t be able to nominate a new candidate from outside the central bank to fill the Vice Chair for Supervision position. Instead, he’ll have to choose someone who is already serving on the seven-member board. Fed Governor Michelle Bowman is said to be on the short list of candidates.
By law, the seven members of the Fed’s Board of Governors are nominated by the President and confirmed by the Senate. The Fed chair and two vice chairs must be confirmed by the Senate for those positions in a vote distinct from their confirmation as members of the Board of Governors. The Fed governors serve fixed 14-year terms that are staggered; one term expires every two years. Governor Adrianna Kugler’s term expires in June 2026, followed by Jerome Powell in January 2028.
The President and Senate have no say in picking presidents of the 12 regional Fed banks—they’re chosen by their private-sector boards of directors, subject to the approval of the (Washington-based) Board of Governors. Patrick Harker is retiring in June 2025, followed by Thomas Barkin in January 2028. With only one nominated position due to turn over within the next three years, the composition and mentality of the Fed likely remains well-grounded near its recent direction.
Unfortunately for borrowers, it no longer appears the Fed will come to their rescue by delivering lower rates. Friday’s strong employment report only reinforced the macro environment that has percolated since the Fed’s September 18 decision. That macro environment includes: growth solidly above 2%; upcoming federal policies that are expected to be, on net, pro-growth, inflationary, and deficit-widening; and stubborn inflation above the Fed’s 2% target.
Rather than kicking off a broad-based rally and lower yields as borrowers had hoped, the decision to cut rates by 50 bps seemed to kick off a bearish tone for mid and long-term Treasuries that has reverberated ever since. Case in point: The yield on the 10-year note has increased by 102 bps since September, even though the FOMC has cut the fed funds rate by 100 bps.
In 2025, something will eventually change the themes, dislodge the market from the “Rocks”, and shift its direction. In the meantime, volatility will continue. Stay tuned.
FROM THE DESK
Agency CMBS — We had a positive first full week of 2025, at least as it related to investor appetite. New-issue Fannie Mae DUS volume was around $550 million last week. In addition, there was around $750 million of Freddie Mac 5-year, new-issue supply in the market. For the week, DUS spreads were 3-5 bps tighter in 5-year to 12-year tenors; DUS spreads were up to 7 bps tighter in 15-year to 30-year tenors. Ginnie Mae spreads were 1-2 bps tighter, week over week (WoW), on low volume.
Municipals — AAA tax-exempt yields were higher throughout the yield curve, WoW. The first full trading week of the year also saw several housing deals price, including short-term housing deals with a mix of premium and par structures. We did see some premium bonds price around 10 bps tighter than par bonds. Given the recent unrelenting direction of rates moving higher, investors may revert to preferring premium bonds in case interest rates continue to rise in the near term. Municipal bond funds had their first week of inflows since early December, with $842 million arriving last week. The high-yield fund subset recorded inflows of $527 million last week.
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
