Politics, Debt, The Fed, The Market

The mid-term elections are over, control of the House of Representatives has shifted to the Democrats, abating political uncertainty for at least two years. Newly elected freshman legislators are undergoing orientation as to the workings of Congress and “life inside the beltway.” Some arrived with ambitious wish lists: Medicare for all, tuition-free public college, a federal jobs guarantee. Some veteran legislators espouse similar ideas, but any notion of such considerations in the House will generate resistance, given the potential tax increases needed to fund costly initiatives. However, market watchers see virtually no chance of such things transpiring given Republican control of the Senate and White House.

That’s not to say that expensive bills won’t pass out of the House but they’re likely to face death in the Senate. Most certainly they would not survive a presidential veto. This observation isn’t political opinion, just reality, i.e., gridlock. Mr. Market loves gridlock! Gridlock will inhibit the rollback of tax cuts and the re-establishment of regulations killed under the Trump administration. The market reacted to the realignment of power in D.C. with an initial rally, but reverting as November rolled on to a see-saw pattern south of the euphoric record highs of a few months ago. Where to from here?

A Wall Street Journal piece, “Debt Costs, Long Quiet, Begin Rise,” by Kate Davidson and Daniel Kruger (11/12/18), offer clues to possibilities. The Federal Reserve Bank has been raising interest rates because the economy is robust, wages are rising with whiffs of wage/price inflation, and inflation may overrun the Fed’s 2% annual target. In 2017, interest rate costs on federal debt, which had seen recent historic lows, consumed 6.6% of government spending. If trends hold, Uncle Sam in the not-so-distant future could spend more on interest than on Medicaid, national defense, and all nondefense discretionary items. Per the Journal, with deficits rising, Washington may borrow twice as much money in 2018 as it did in 2017.

If we relate debt as a share of GDP, it may climb in ten short years from 78% this year, “the highest it has been since the end of WW II, to 96.2%.” (WSJ). While not as bad as some of the basket cases in Europe or emerging economies, our debt pile is growing. With storm damages on the Gulf Coast and the southeast, fires in California and the west, disaster relief will be a big item, widening deficits.

Plummeting oil prices will take some of the edge off of inflationary pressures, easing pump prices and transportation and other costs. That’s good news. Democrats want to push infrastructure spending by rolling back some tax cuts, but the Senate is an obstacle. Massive infrastructure spending sans tax hikes is not likely given federal borrowing approaching $1 trillion this year alone.

The Federal Reserve Bank, while independent and supposedly immune to political pressure and President Trump’s tweets, has to deal with conflicting forces. Some countries like Russia are dumping dollar holdings in response to sanctions, but so far that has not impacted our ability to borrow money. But if the bond vigilantes demand higher interest compensation for lending money in the face of rising inflation, and the Fed continues to raise rates, the more the squeeze on government spending priorities. Will the Fed ease up? Only time will tell.

Reality suggests that no budget-busting initiatives are likely to overcome gridlock. As far as your 401(K) is concerned, that may be a good thing!  As to fixed income, rising interest rates make the laddering of CD and bond portfolios more meaningful. Rising rates benefit savers but pain borrowers and debtors with adjustable rate debt. Mr. Market doesn’t like rising interest rates. Yin and yang.

At this writing pre-Thanksgiving, talking heads debate warnings of a “late-cycle slowdown,” citing nervous CEOs, sluggish growth abroad, and tariff worries. However, on 11/15/18, “Mad Money” host Jim Cramer postulated, “If the Fed changes course and says ‘No more rate hikes …next year unless the data gets more positive,’ or if President Trump gets a trade deal with China (or even a truce), end-of-cycle proponents may have to change their tune and the market can rocket higher.”

Regard general commentaries and the ravings of pundits as a form of entertainment. How such ponderings might impact you are the subject of individual reviews and conversations and an in-person update with your advisory team, always advisable. Any material changes in your investment mix should be tailored to your specific circumstances. If end-of-year tax planning is called for, time is very short!

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