Written by Steve Andrews
November’s Key Events
It will be hard for the remaining days of the month to top the events during the first week of November. The American electorate returned Donald Trump to the White House with what seems to be a mandate, given the margin by which he won and the fact that the GOP also won both the House and the Senate. Then, a few days later, the Fed cut short-term interest rates for a second time in as many FOMC meetings.
US stocks rallied sharply, enjoying their biggest post-election run-up in history. The business world seemed very happy with the election results as well as it assumes that a Republican White House, Senate, and House of Representatives will extend the Tax Cuts and Jobs Act (TCJA), foster a cut in the corporate tax rate, and provide some relief from the mountain of new regulations put in place by the outgoing administration.
The Fed Rate Cut
Touching upon the Fed first, its Federal Open Market Committee (FOMC) cut the Federal Funds rate by 25 basis points. The Fed and Chairman Powell have been so enthusiastic about cutting rates since back in August, when Powell spoke at the Fed's Jackson Hole, WY economic forum, they almost had to cut rates this month so as not to show deference to whoever won the White House. The November FOMC vote to cut rates was unanimous, unlike September's vote.
We have been highlighting over the past few months how well the economy has been holding up but Jerome Powell and the FOMC believe that US monetary policy is too restrictive because the Fed Funds rate remains well above its "neutral" rate (which is believed to be somewhere around 3.00%). In announcing the rate cut, Powell said: "We know that reducing policy restraint too quickly could hinder progress on inflation. At the same time, reducing policy restraint too slowly could unduly weaken economic activity and employment." Those concerns aside, Powell also said that both the economy and employment are "in a good place."
When asked about the recent rise in Treasury bond rates, he said that the 61 basis point rise in 10-year Treasury yields was mostly a result of stronger economic growth and diminished recession risk. He downplayed the impact of higher inflation expectations even as the gap between the yields on US Treasuries and TIPS (inflation-indexed Treasury bonds) has widened of late.
Mixed Signals in Employment and Productivity
We agree with Powell on this matter because long-term interest rates are transitioning from expecting a recession, to expecting a soft landing for the economy. Yes, employment growth seemed to stumble in October, with non-farm payrolls rising just 12,000 for the month but, unless we get similar disappointments in the months ahead, it appears that the shortfall was due to the hurricanes which affected a large portion of the southeast and kept over 500,000 workers from their jobs. Meanwhile, a separate survey conducted by the payroll services company ADP showed that US private companies added 233,000 workers in October - the largest increase since July 2023. This, despite the hurricanes and the strikes at Boeing and US ports.
US productivity (which, combined with job growth, determines GDP growth) rose 2.2% (annualized) in Q3, as output increased 3.5% and hours-worked rose 1.2%. Manufacturing productivity grew 1.0% while productivity in the business sector rose 1.7% from Q2.
Manufacturing vs. Services Trends
While growth in the US Manufacturing sector continues to struggle, the US Services sector, which makes up over 80% of US GDP growth, has remained strong since the economy reopened. The ISM Non-Manufacturing Index rose to a muscular 56.0 last month – its highest reading since July 2022 - from 54.9 in September, with fourteen out of eighteen major industries surveyed reporting growth.
Rising Federal Deficits
We believe that stocks and interest rates are rising for the right reasons – expected stronger economic growth among them – but rates may also show some concern over federal debt and budget deficits. September 30 brought the US fiscal year to a close and the federal budget deficit rose to $1.83 trillion - the largest in history when we exclude the pandemic years. The deficit represents 6.4% of US GDP, following 6.2% in fiscal year 2023. Since World War II ended, we have never seen the deficit rise above 6.0%. This includes the Cold War, and the Korean and Vietnam Wars. What's worrisome is that this has occurred at a time when we were neither at war nor experiencing a recession or a credit crunch – situations when some believe that massive government spending is warranted. During the fiscal year that just ended, the US treasury spent $882 billion on interest expense, approximately $2.4 billion per day. According to the Treasury Department, this was the highest ratio of interest expense to GDP (3.06%) since 1996. The expense for interest exceeded the Defense Department's spending on military programs for the first time, amounting to nearly 18% of federal revenues — almost double the ratio from 2022 – and will exceed $1 trillion this year.
It's not a lack of revenue that's causing the rising deficits, as they rose 11% for the fiscal year, thanks to higher tax receipts which were fed by robust employment and strong wage gains. It's the runaway federal spending that, no doubt, some Americans gave some thought to at the ballot box. The Congressional Budget Office estimates that every additional dollar of deficit-financed spending reduces private investment by 33 cents. That private investment drives hiring and productivity growth, which feeds GDP growth. Prolific federal spending since the Great Recession in 2009 is why US GDP growth has slowed from its long-term (since the 1940s) average of 3.1% annual growth to 2.2%.
In Conclusion
The new administration is planning to address federal spending to look at ways to reduce the deficit. It's not an impossible task. At current GDP growth rates, it has been estimated that we could pay off the federal debt in seven years if we could somehow hold federal spending at current levels. Commissions to reduce federal spending have been tried several times over the past 40 years without much success.
In the meantime, our post-COVID recovery continues, fed by steady consumer spending and rising business investment as companies ease off their recession watch. As of Q3, US GDP growth has averaged 2.8% over the last nine quarters - a good bit better than what we averaged (2.1%) in the decade following the Great Recession in 2009. And the prospects for continued growth look good if President-elect Trump and the GOP can deliver on their campaign promises. Time will tell.
