The Coming Shifts
Policy and Geopolitics
The blood-dimmed tide is loosened, and everywhere/The ceremony of innocence is drowned.
-W.B. Yeats, 1921
THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.
I am thinking about two key events coming down the pike. We know they are coming. We can’t say exactly how they will turn out, but need to come up with probable scenarios, a central case.
The first event is the Fed easing. Do they cut? Yes. But do they cut 25 basis points or 50 next month? It seems like a small detail and, a few years from now, we won’t remember the drama. We are talking about the difference between 1/4 and 1/2 a percentage point. But it’s a big deal for asset prices and the economy.
The second event is the US election. The US election matters some for the economy—Harris wants to raise taxes, Trump to cut—but it matters more to the international order.
Since the early 20th century, the world has turned on a good/evil axis. That’s a little overstated but not too much. The Soviet Union was evil. So was Nazism and Maoism. Liberal Democracy was, by comparison, much better. Yes, sometimes the liberal Democracies did things that were also evil. Supporting despots, constraining civil rights for swathes of their population, allowing lax regulations on the production of terrible chemicals, like oxy, or woefully screwing up the economic policy during the Depression and the 1970s all tainted the shine. Still, you only needed to spend a little time in the Soviet Union to see the degrees of evil were magnitudes apart. It’s against that backdrop this election is a big deal. Trump is isolationist, Harris is internationalist and isolationism means a stronger Russia and China.
At present, expert opinion is that a) the Fed will cut 25 basis points in September and b) the Presidential race is almost a toss-up. Below are the odds of a Fed cut:
Below are the election odds from 538.
So here is my hunch.
The Fed is going to cut 50 in September and Harris is going to win. It’s worth noting that the Fed cutting may also boost Harris’s odds of winning, though that isn’t why they will do it.
To be sure, the Fed themselves don’t know what they will do on September 18. Likley some of them are thinking “let’s wait for the employment data on September 6. If it’s strong (as it is supposed to be) let’s cut 25. If it’s weak, then we can consider 50.” But if you listen carefully to what they are saying, they are correctly identifying the dominant risk has shifted to weaker employment from strong growth. Data is always mixed, but there is enough of it to suggest the fear of higher unemployment is well-placed. My north star in this episode has been short-term real interest rates. At 5.3%, if inflation is around 2%, that’s a 3% real rate which is too high to allow strong economic growth. Once that is recognized and the impacts (softer employment) are clear, cut and cut quickly. This, as I have shown above, is not discounted; a 32 basis point cut is discounted.
On the election, I suspect independent voters in swing states—upon whom this election will be determined—don’t want a convicted felon representing the country. It’s that simple. They may prefer some of his economic policies, but the Trump brand is tarnished, the act old. All the Democrats had to do was put in a reasonably unoffensive candidate and they win. To be clear, Harris’s economic policies make no sense to me. Cracking down on price gouging? How is the Federal government going to determine the fair price of a pork chop? Yet, In terms of international affairs (which most Americans don’t care about) there is a stark difference between Harris and Trump. Harris wants to defend Ukraine. Trump either doesn’t or isn’t letting it be known.
I can’t prove to you that either of these outcomes will occur. It isn’t in the data. But the logic points to those outcomes and to see the future you need to imagine the entire interaction. The logical outcome is:
Short-term US interest rates fall.
Long-term interest rates rise relative to short-term interest rates.
Companies with safe, reliable cash flows rise in value.
A wave of money goes into defense spending in the US and Europe.
Ukraine stands and, seeing this, Xi doesn’t invade Taiwan.
The next step in the process is figuring out what to do if my predictions are wrong, but that is a conversation for a later day. I will be traveling this week, so no post on Friday.