Sticky inflation and uncertain government policy has one portfolio manager predicting that Powell is done cutting
Rose Devli believes that the US Federal Reserve will not cut its rates until the United States enters a recession. That view comes despite the consensus on equity markets that the Fed’s next move will be another cut. Devli is a portfolio manager for fixed income at Dynamic Funds. She believes that the state of US inflation and the unpredictability of government policy may leave the Fed’s hands tied until the US experiences a growth shock.
Devli outlined some of why inflation in the US has been so sticky. She explained what US policy under President Donald Trump might mean for the predicted path of Fed interest rates, and outlined why she believes Powell is unlikely to cut again. She previewed, too, what might cause a growth shock in the United States and highlighted some of the strategies advisors can use to navigate these uncertain times.
“We're in a very difficult environment. The Fed is still talking about above two per cent inflation for 2025 and heading into 2026. And we were talking about that in 2023,” Devli says. “And then you add in Trump and the way that he's going about tariffs. He’s not really backing down as the market expected him. It's tough to see an environment where inflation comes smashing down, unless we have a recession [in the United States].”
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Because markets are so incredibly influenced by Fed and government policy, Devli says, this dynamic may play out in fixed income and equity markets over the coming months. She believes, as well, that equity markets are currently pricing in a ‘Goldilocks scenario’ where inflation continues to run above two per cent but the Fed does not hike. So long as the consensus remains that the next Fed move is down not up, then equities look attractive. Devli says that other indicators point to a less-attractive outcome: stagflation.
Looking at gold and silver markets, Devli sees US stagflation beginning to be priced in. She notes that the US economy under the first Trump and Biden administrations was buoyed by a huge amount of government spending, somewhere around six to seven per cent of GDP. Trump has now ordered widespread slashing of federal spending, largely through layoffs. Around 75,000 federal employees have taken a buyout, so far, and other government agencies seem to be on the chopping block. That could produce a growth shock while inflation remains somewhat elevated.
“In the current environment we don’t expect the Fed to be able to cut interest rates at all, the biggest risk is that they turn Hawkish,” Devli says.
Key to this outlook is the fact that many of Trump’s cuts appear to be laying the groundwork for some significant tax cuts. Those tax cuts may add fuel to the inflationary fire if they give more spending power to US consumers. US consumer credit rates had begun to tick up recently as the fables US consumer resilience appears to be capitulating somewhat. Retail numbers were also disappointing, albeit coming from January when spending tends to dip. An income tax cut could result in an inflationary uptick and yet more uncertainty for markets, Devli says.
Policy uncertainty is one thing, but with President Trump another source of uncertainty is his propensity to threaten, bully, and speculate. The noise coming out of the White House, Devli says, is difficult to quantify. Nevertheless, central bankers have to consider it. The threat of tariffs, for example, must be part of central bank decisions now, whether they manifest or not.
This is an environment where Devli believes active management can offer advantages for advisors and investors. She sees a great deal of opportunity in fixed income right now looking at Canada and global markets. She believes, though, that passive index tracking within fixed income subjects investors to undue headline risk and volatility. Experienced asset management should be able to help navigate those stormy waters.
“It’s important to be more agile in this type of macro environment. I think those advisors that have relied on being stock pickers or on big shifts without much volatility those are the type of advisors that that probably are going to find the environment very tough in the next four years,” Devli says. “I think the advisors that can succeed are telling their clients, listen, we're here for you, and we are adjusting the portfolio, or thinking about what could happen in different scenarios. For example, having scenario analysis to show a base case, a bear case, and a bull case, and being able to move and shift given the macro environment. Those approaches can succeed.”
