The Market is Right: Fewer Rate Cuts Expected After Trump's Victory

In the wake of Donald Trump's decisive presidential election victory, financial markets have reacted swiftly, with the U.S. stock market surging and Treasury yields dipping. One prominent voice in the market's response has been former Fed policymaker Loretta Mester, who expects fewer rate cuts next year. This article delves into the reasons behind Mester's prediction and explores the potential implications for investors.

Mester's expectation is rooted in the market's anticipation of Trump's pro-business stance, which includes lower corporate taxes and deregulation. These policies are expected to boost economic growth and, consequently, inflation. The market's reaction to Trump's victory reflects this optimism, with the Dow Jones industrial average surging more than 1,500 points, or 3.6%, in the afternoon after the election.



However, while the market's initial reaction is bullish, investors should be mindful of the potential challenges that Trump's policies may pose. Economists like Mark Spindel and Michael Strain warn that Trump's proposed tax cuts and increased spending could lead to higher deficits and inflation. Strain notes that Trump's tariff plans could also contribute to inflation by raising prices on everyday products for consumers.

To balance its mandate of maximum employment and price stability, the Federal Reserve may need to adjust its monetary policy in response to Trump's policies. If Trump's policies stimulate the economy and drive up consumer prices, the Fed might end its rate-cutting plans earlier and leave rates higher. This could put the Fed in conflict with the Trump White House, as the Fed seeks to maintain price stability while supporting maximum employment.

The bond market is also likely to react to potential inflationary pressures and changes in fiscal policy under Trump. Tina Fordham, founder of Fordham Global Foresight, warns that Trump's policies are inflationary, which could intersect with expectations about the Fed's rate-cutting cycle and geopolitical risks. Investors are already pricing in fewer rate cuts next year, with futures market pricing indicating a scaled-back expectation for reductions over the next 12 months.

Geopolitical risks and trade policies under Trump could also impact global markets and the Fed's rate-cutting cycle. Trump's proposed tariffs and immigration policies may lead to higher inflation, which could deter the Fed from rapidly easing monetary policy. Economists warn that several of Trump's proposed policies, including corporate tax cuts and deportation of millions of immigrants, could cause a resurgence in inflation.

In conclusion, the market's initial reaction to Trump's victory reflects optimism about his pro-business policies. However, investors should be mindful of the potential challenges that these policies may pose, including higher deficits, inflation, and geopolitical risks. The Fed and the bond market will likely play crucial roles in managing these challenges, and investors should closely monitor their responses. As the market is right in expecting fewer rate cuts next year, investors should also be prepared for potential headwinds and adjust their portfolios accordingly.