The inability of the Trump administration to enact legislation and the current posture of the Federal Reserve are beginning to cause concerns that they may threaten domestic economic growth expectations. In our last letter, we noted that the “Trump Trade” could potentially stall due to concerns that the current administration may not be able to implement its optimistic agenda of robust tax cuts combined with substantial infrastructure spending that it promised during the campaign. This concern came into sharper focus in early July as the attempt to pass sweeping health care reform ran into trouble when Senate Republicans could not agree on the legislation that would repeal and replace Obamacare. While the repeal of Obamacare may eventually pass, this turn of events casts into doubt the administration’s ability to implement a robust infrastructure spending package and tackle the more complex issue of tax reform, both of which would likely have a more substantial effect on financial markets than health care reform. Failure to pass these two initiatives in a timely and meaningful manner may exert downward pressure on markets.
The Federal Reserve continued to tighten monetary policy during its June meeting by announcing a 0.25% hike in its benchmark interest rate. The Fed also announced that it would begin reducing its balance sheet, which has grown to over $4 trillion, in an attempt to “unwind” the scheduled asset purchases it has made as part of its quantitative easing program. While the timing is still undetermined, the Fed plans to runoff maturing principal payments initially of $10B per month, gradually increasing to $50B per month. The Fed’s ability to subtract trillions of dollars’ worth of fixed income securities from its balance sheet without flooding the market and driving down prices will be an unprecedented challenge.
The realization that fiscal stimulus might not materialize and the reality that the Fed is clearly entering into a period of greater monetary tightening through both rising rates and balance sheet reduction lead us to conclude that the headwinds to the growth of the domestic economy are increasing. In an environment where markets are priced at or near perfection as noted in the prior section of this letter, investors should expect significantly lower returns over the next decade than they realized over the last decade.