Speakeasy

400 Proof  

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Federal Reserve Governor Chris Waller and the Bank of England’s Alan Taylor are literally doubling down on rate cuts. They spoke on both sides of the Atlantic last week, and this duo was clear that their 2025 rate forecasts were for twice what the market expects. Waller exuded optimism Thursday, expecting inflation to hit 2% with no sustained upside surprises, even with tariffs. He is looking for three to four cuts this year, with the first move possibly as early as March. The market is pricing in one to two cuts in the second half of this year. Alan Taylor, who joined the Bank of England’s (BoE) Monetary Policy Committee in September, was in the minority when he voted for a December rate cut. He forecasts the underlying trend of inflation to remain on track towards the BoE’s 2% target, in harmony with Waller. Taylor favors four pre-emptive rate cuts to avoid a recession in 2025, double that of consensus UK rate cut expectations.

These two seem to be outsiders. The BoE left rates unchanged, blaming the same price persistence referenced last week by Germany’s Bundesbank President Joachim Nagel. Nagel made it clear he is concerned about a resurgence of high inflation. This sounds more like the tone the Federal Open Market Committee (FOMC) adopted in December’s Summary of Economic Projections where they fear their inflation forecasts could be too low. Waller admitted he is more optimistic than his colleagues. Yet, he argued he is not too far outside of the consensus. He agreed there is general unease about inflation, but the range of 2025 Fed funds forecasts among FOMC participants stretched as high as five cuts.

Core PCE price data is scheduled for January 31, after the January 28-29 FOMC meeting, where rates will be left unchanged. Although the market consensus is not in line with Waller, if the inflation report comes in steady, investors will remember Waller’s optimism and celebrate.

On Your Mark(s)  

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Howard Marks is thinking about blowing bubbles again. The co-founder of Oaktree, the world’s largest distressed investment firm, wrote a timely warning about an impending bubble on January 7, 2000. Marks revisited the theme recently, twenty-five years later. He stopped short of calling a market top but he sent a sober message to long-term investors. He warned that the final stage of all bull markets occurs when “everyone concludes that things can only get better forever” and people lose objectivity over innovations that are “either overestimated or not fully understood.”

Those extremely optimistic biases push equity valuations to the limit. While Marks says the current price-to-earnings ratio of the S&P is high—as is the p/e ratio for the magnificent seven—the index is not approaching the extremes of other blow-off tops such as 1973 and 2000. However, that does not mean he is not worried. Marks referenced a JP Morgan Asset Management report that is an update of older studies charting the S&P 500 forward p/e ratio against its 10-year annual return. December 2024’s p/e ratio of 22x ranks in the 98^th percentile of all monthly readings going back to the 1990s. When valuation gets this stretched, the S&P 500 tends to be flat in 10 years’ time. That projects the S&P 500 to be around 6000 in December 2034.

While one can extrapolate 10 sequential years of near-zero annual performance, the historical pattern points to a gut-wrenching bear market that eventually claws its way back to today’s highs. That translates to a prolonged period of owning underwater equities. As Howard Marks warned in 2000, be prepared to get defensive and allocate to other asset classes, perhaps not today, but sometime in the future.

Sovereign Wealth Fund: Really…Now?

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Donald Trump wants to create a Sovereign Wealth Fund (SWF) in the U.S. during his next term.  Sovereign Wealth Funds are a collection of assets managed at the government level that are comprised of stocks, real estate, and bonds. The profits can pay for government expenditures or be used strategically, such as securing foreign sources of strategic materials. The UK plans to put a small toe in the water with plans to initiate a $9 billion fund, less than one percent the size of the mammoth Sovereign Funds in Norway, Saudi Arabia, China, and UAE. The American Sovereign Wealth Fund Exploration Act was already introduced into Congress in September 2024. Given global acceptance and momentum, it seems to be in favor of us doing the same.

We would ignore any investor excitement over government-funded equity purchases for now because it is premature. If it does happen, it is a red flag.

Before opening such a fund, there is a need to set up guardrails to avoid staffing conflicts or favoritism and to establish standards for making long-term capital asset decisions. The partisan fights that could break out in Washington over sourcing the funds, independence vs. oversight, administration, portfolio composition, and payout of any profits would detract from more pressing legislation favored by the administration. More importantly, it is no surprise that resource-rich exporting nations have created the largest funds financed by their respective trade surpluses. While the U.S. is the preeminent crude producer and plans to increase domestic oil production, oil revenues do not flow into government coffers. There is the possibility of using tariff revenue to fund the SWF, but most likely it would come from debt issuance. Last week at his confirmation hearing, Scott Bessent said, “we need to get our short-term fiscal position in order before considering asset plans such as a sovereign wealth fund.” The need to borrow to obtain assets for the SWF works at counter-purposes to Bessent’s goal of dropping the fiscal deficit to three percent of GDP. The markets may push back if the project looks like it will go through.

What to Look for This Week

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1. Monday, January 20. A table is already waiting for President Trump to sign an avalanche of executive orders after he is inaugurated at high noon E.S.T. Tariffs remain the most obvious risk to the equity bull case. From this morning’s news releases, it appears that there will be no immediate tariff roll out. Instead, there may be an executive order instructing government agencies to conduct their own investigations of fair trade practices focused on China, Mexico and Canada. This is leading investors to believe there will be a ramp-up period to allow trading partners to begin negotiating before tariff implementation, hopefully on targeted products such as technology. This is also encouraging news that the European Union may see limited tariff action, although we know the outlook may change quickly.

2. Thursday, January 15 at 8:30 a.m. E.S.T. Initial Claims. The four-week moving average of initial claims just hit its lowest level since April 2024. The first week in January always sees peaks in non-seasonally adjusted claims, and this year was no exception, with last week’s number coming in at the highest level since last January. We will be watching that non-seasonally adjusted series to see if it comes down, as expected.

3. Thursday, January 23 at 9:30 p.m. E.S.T, the Bank of Japan releases the result of its Monetary Policy Meeting, followed by its Outlook Report 30 minutes later, and Governor Ueda’s press conference is on Friday 1:30 a.m. E.S.T. CPI comes out at 6:30 p.m. E.S.T. Thursday and could cement expectations for a 25-basis point hike. The Official Deposit Rate is expected to rise to 0.50%, the highest level since the BoJ’s March 2007 hike, which contributed to the Nikkei peaking ahead of the S&P’s October 2007 highs.