"While now is the time to begin dialing back the restrictiveness of monetary policy, it remains to be seen how much further interest rates will decline or where they might eventually settle."

That’s a direct quote from the Kansas City Fed’s President Jeffrey Schmid. In that one statement he brings up several things that can affect asset markets going forward. For starters, he calls into question the pace of rate cuts that both the Fed has signaled and that markets are pricing in. But he goes further and wonders aloud how low the Fed can really go. That’s a big deal, not only because it impacts the value of US Treasury debt, the world’s biggest asset market, but because a higher or lower fed funds rate will also change asset allocation from money market funds to equities and beyond.

My own view is that inflation has stalled above the Fed’s target. And when you combine that with likely large US fiscal deficits, it suggests the terminal rate where the Fed stops cutting is higher than what’s priced in. That’s very bad for the housing market, housing stocks, and the inflation embedded in rents. In turn it also means all of the money collecting interest in money market funds will continue to stay put, making the status quo of a Big Tech-led US market the base case for the indefinite future.

I’ll lay out a few arguments below in support of this thesis, including the following main points:

• Interest-rate hikes and cuts act very differently in today’s US economy because of the 30-year mortgage
• The corollary is that high rates may actually spur certain types of inflation, namely purchases by upper-income households and rents
• This all spells higher for longer even before you get to the fiscal picture 

When it finally dawned on financial markets in 2020 that Covid-19 was a pandemic that would affect everybody, there was a panic that threatened to usher in another financial crisis. Among the many things the Fed did was cut interest rates to zero and keep them there. In fact, it was exactly two years before rates moved higher.

For those of you fortunate enough to have recognized this as a once in a lifetime opportunity to lock in a fixed 30-year mortgage rate below 4%, even below 3%, I applaud you. The borrowing cost, the liability, on your biggest asset won’t ever be as low again in our lifetimes. Of course that means you’re kind of stuck where you are unless you’re willing to pay a higher rate if you sell and buy another home. But it also means that Millennials, now desperate to get on the property ladder, don’t have a lot of housing inventory to choose from. They have to buy a house whose price was bid up throughout the pandemic and afterwards using a costly mortgage. Or they have to rent. That makes rent inflation as onerous as owning. Two terrible choices.

And a lot of this is driving both electoral politics and inflation statistics. On the inflation side, rent inflation in the year through October came in at a whopping 4.9%. The corresponding figure for homeowners, owners’ equivalent rent, was even higher, registering 5.2% in the last 12 months. If you’re a Baby Boomer or Gen X’er who already owned a home, none of that factors into your personal inflation. But for those still renting or looking to buy, it’s a big deal. And the US presidential election shows that. Exit polls show that those most likely to rent — young people and people of color, swung against the Democratic Party the most. Even if they are more likely to vote for Democrats, that likelihood swung tremendously in favor of Donald Trump in 2024. Conversely, those most likely to own homes and insulated from shelter inflation, older people, swung against the Democrats the least. Ian Bremmer gets it!

My takeaway: everyone hates when prices go up. “Despite substantial postpandemic increases in food costs, wages have now more than caught up with prices”, people still feel poorer from the rise in food prices. Call it money illusion, but the reality is even if groceries are getting more affordable in real terms, people see the price compared to 2019 before the pandemic and just don’t feel it.

So what does the Fed do about this? Go back to that quote from Jeffrey Schmid right up front. He’s telling you that, if inflation fails to go down, the Fed is not going to cut rates a lot more.

I’m telling you the more they do that, the less housing inventory there will be, keeping house prices elevated. That will continue the one-two punch of high mortgage rates and high house prices that is hurting Millennials (a generational cohort still trying to get out from underneath large student debt problems).

So higher rates may actually fuel inflation, first by adding to shelter inflation and secondly by boosting spending among Gen Xers and Baby Boomers who are getting 4% on their money market fund savings and who dominate upper-income household spending, which in turn has driven this economy’s boost.

Let me give you an example. The headline from Bloomberg says “Walmart Raises Outlook on Strong Spending From Value-Seekers.” But when you read the article you see this right near the top:

A lot of that growth was driven by upper-income households making $100,000 a year or more. That cohort made up roughly 75% of share gains for the quarter.

Translation: Bargain-hunting but upper-income Gen X’ers and Baby Boomers are driving both the spending and the profits at formerly more down-market stores like Walmart. We’re not talking about Target aka Tarjay here. This is Walmart, the store known for dominating staple purchases for ordinary Americans. In fact, Walmart is courting these people by advertising a complimentary Walmart+ subscription for all American Express Platinum Card holders. This mirrors what I highlighted about GM a few weeks ago, “even though the broader market for GM’s cars is pretty soft, the high-end stuff is doing so well that GM was able to post better-than-expected profits.” Add Walmart to that list.

If I had to synthesize all of this into a big picture for asset prices, I would say this: there’s no recession on the horizon because of upper-middle class households. And that’s good for risk assets irrespective of what interest rates do. So it’s pretty much steady as she goes in terms of asset allocation, with megacap tech continuing to dominate S&P 500 returns. Let’s see how Nvidia does to know if that’s a good thing or a bad thing in the near term. Over the medium-term, as long as the economy holds, it means stock chart that go up and to the right.

This whole confluence of events also means there won’t be a flood of money rushing out of money market funds as many have been predicting. There’s no reason to take huge maturity/duration risk. The yield curve is still inverted. Sure you can safely go out to two years without losing a ton of yield. But those assets mature soon. So the risk is small. Still, the $325.2 billion pile of cash I told you last week Warren Buffett has tells you there’s no reason to start moving your money out of money market funds.

Two things happened in the last week that lend more support to that big picture. The first is the inflation prints from the US, the UK and Canada. All three showed a re-acceleration in inflation and a greater likelihood of  the ‘higher for longer’ rate regime. Europe, beset by an anemic German economic anchor is a different story. Irrespective, the disinflationary trend has stalled and we’re now seeing a slight re-acceleration of price levels.

Central banks will respond by slowing their cuts, bolstering my thinking about higher long-term interest rates in the US as well.  But since the pandemic made high rates less likely to slow the US economy, that medicine has to be administered for much longer, risking recession if it is to work.

The second thing was the business response to potential tariffs, a signature part of the Trump policy agenda. So far four companies plan to raise prices if Trump’s tariff agenda goes into effect: AutoZone, Columbia Sportswear, Stanley Black & Decker, and now Walmart. I see that last one as the real killer given its importance to ordinary consumers. The Walmart CFO said this to CNBC:

“We’ve been living under a tariff environment for seven years, so we’re pretty familiar with that,” he said. “Tariffs, though, are inflationary for customers, so we want to work with suppliers and with our own private-brand assortment to try to bring down prices.”

The irony then is that the people who swung to Trump because of inflation may actually not get the relief they’re looking for. In fact, with higher deficits and tariffs, Trump’s agenda may end up boosting inflation even more.

• Trump could create a White House crypto czar. That’s bullish for Bitcoin.
• It’s not just Jerome Powell but also Michael Barr who is defying Trump’s desire to control the Fed.
• Commercial Real Estate is having a negative impact. Will it be a big 2025 market issue?

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