Chris Wallis, CEO and CIO at Vaughan Nelson, discusses changing interest rate and inflation expectations and looks at what is likely to happen after the US election.

Recorded on October 24th, 2024

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Lightly edited transcript

Dan Hughes:  Welcome to the Vaughan Nelson podcast. With me today is CEO and CIO, Chris Wallis. Welcome, Chris.

Chris Wallis: It’s great to be here, Dan.

Dan: All right, Chris, so it’s been a few weeks since we last recorded, since we spoke and connected. The Fed cut rates and then we saw rates go higher, right? So maybe explain this one to me, right? What’s happening here?

Chris: Yeah. Look, as we’ve always said, the Fed follows the market and we’ve also discussed that they were going to cut rates and it was going to steepen the curve. And while that may be negative for interest rate-sensitive stocks, it’s actually a positive overall because it’s going to allow a little bit easier environment to fund deficits. And we’ve also discussed the fact that, look, we were nearing the bottom in inflation expectations. So the Fed was going to be cutting rates into rising inflation expectations. That’s just kind of how it’s played out.

So we’ve seen a move higher in rates. They’ve cut 50 basis points, and for the most part, interest rates have moved up 50 basis points. I think there could be another 30 to 50 basis points move higher over the shorter term in interest rates and that’s about it for now. Inflation is going to bottom and we’ll see it start to tick up and probably go back up through 3% in the first half of 2025. But as it stands today, it’s not going to get away from us. It’s just not going to get back to the 2% that everybody thought. So we’re going to be changing interest rate expectations and Fed expectations. But at the end of the day, look, the Fed’s cutting interest rates to help fund deficits as much as anything else. So steeper yield curve, not much change in interest rates and maybe we’ve seen the low in interest rates already, so it’s going to be a choppy environment.

Dan: Yeah. And thinking ahead here, so we’re under two weeks from the election, we won’t connect again until after the election. Thinking about depending on who wins, do we have any short-term implications for what’s going on with the market?

Chris: Yeah. Look, as you know, I’ve said they’re going to pump liquidity into the system going into the election and it certainly looks like they’re doing that. I know there’s some apprehension about who wins going into the election, and so quote, “the Trump trade” was moving markets a few weeks ago. The reality is it was just a reflation trade because inflation expectations were moving higher. I don’t think short-term, it’s going to matter at the index level. You’ll see different winners or losers from a sector standpoint, so financials will clearly do better under a Trump administration than a Harris administration.

But regardless, my expectation is we’ll get through the election, we will get rid of the uncertainty as to what the outcome of the election is. And as long as that is the case, there isn’t any uncertainty, I think the market rallies. I think it’s set up structurally to rally the liquidities there. The option positioning is there and we should start rallying end of December, whether it goes through mid-January or not. We’ll see. But short term, I think we’re set up for a relief rally post the election.

Dan: Yeah. And just touching on your comments that you described there. Does your setup for ’25, think about through December, but does your setup for 2025, does that change depending on who you think ends up in the White House?

Chris: Not really, because look, there’s been a lot of changes since the last time Trump won office and if he wins this time, there’s not going to be the same level of overall flexibility. And what I mean by that is the deficits are much higher, the interest on the debt is much higher, interest rates are much higher. There’s been structural change as to degrees of freedom within the executive branch with the Supreme Court striking down Chevron deference. And look, at the end of the day, we got tax cuts expiring. We’re going to have real crowding out of the private sector from the deficits. Inflation is going to pick back up. You can’t really run the economy too hot or inflation is going to get to be an issue as well as funding deficits. There’s going to be a battle between the Federal Reserve and the White House if Trump’s elected, so there’s going to be a little bit of uncertainty there. And those same elements are going to exist with the Harris administration.

So I think as we move into ’25, the economic setup is the services side of the economy is fine. While the manufacturing side may have bottomed, it’s going to be choppy. There’s not a big inflection. We’re going to see an increase in IRA funds for infrastructure continue to ramp the next couple of years. But look, the equity risk premium’s about as low as it can go. Inflation expectations near term are about as low as they can go. It’s not clear what tax rates will be as we exit ’25. And I really think over the next couple of years, we’re really going to have to start dealing with these deficits. And there’s going to be talk of tax increases or cuts in spending or massive restructuring of the government bureaucracy, all of which is kind of negative for economic activity. So I think it’s going to be fairly choppy as we move through 2025 and beyond.

Dan: All right, well, that’s a good place to stop for today. A lot of travel coming up in the next few weeks, but we’ll have you back here shortly and look forward to it.

Chris: Sounds good, Dan.

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