The market was excited about the Donald Trump tax cut in his first administration. It rallied for all of 2017 and into early 2018 before the speculation in volatility known as Volmageddon roiled markets in February 2018.
This time around it’s more about extending some of the benefits. Given the increased fiscal limitations (worse debt and deficits) this time around, we are not sure Congress can be as liberal with additional cuts, but time will tell.
The appointment of Scott Bessent, a known fiscal conservative, to lead the U.S. Treasury may help craft a smarter way to extend cuts. Global capital markets liked the nomination based on the response on Monday morning.
In 2017, both nominal gross domestic product (GDP) and the U.S. consumer price index (CPI) rose as the wealth effect likely helped to boost both.
A strong wealth effect in 2024 with inflation falling was a bullish combination that almost nobody expected, but is in the rearview mirror, opening up 2025 to being more like 2018 than 2017.
The Federal Open Market Committee (FOMC) had started to raise rates from the ZIRP (zero interest rate policy) for most of 2017 and 2018 to “normalize” policy. In addition, it started to shrink the balance sheet in 2018 as well to make policy more restrictive.
This is a bit different this time around and would be less of a headwind in 2025 than it was in 2018. Thus, 2018 was a tougher year for the market having anticipated the benefits of tax cuts well before they were signed into law in December 2017.
This time around, there are few, if any, new tax cuts like we saw during the first administration, and the market’s rally is more of a continuation than a net new stimulus, from our lens.
Trump used tariffs in his first administration and several independent analyses have shown they hurt manufacturing jobs and added to producer prices. Most do not see this as a net positive to economic growth and specifically to the inflation outlook that has been a tailwind.
Equity market weakness in late 2018 likely caused the FOMC to pause rate hikes and eventually pivot back to cutting rates in July 2019 followed by an increase in the balance sheet (more QE).
Bottom line: financial conditions run the FOMC, so as long as financial conditions are easy, the market will likely hold in.
What kills the market this time around? “It’s the economy stupid,” as the phrase goes that was coined by Democratic strategist Carville in 1992.
On that front, GDP, inflation and employment are currently positive catalysts looking into 2025. Higher-than-expected inflation and weaker employment are the negatives that tariffs will likely complicate, and markets will likely have adverse reactions to.
The market is celebrating the nomination of Bessent as he a seen a modifier to the aggressive tariff regime that Trump threatens.
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