Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Global Markets, the Markets and Financing Division of State Street. I'm your host, Tim Graf, European Head of Macro Strategy. Each week, we bring you the latest insights and thought leadership from our award-winning suite of research, as well as the current thinking from our strategists, our traders, our business leaders, and a wide array of external experts in the markets. If you listen to us and like what you're hearing, please do subscribe, leave us a good review, get in touch with us. It all helps us improve what we hope to bring to you. And with that, here's what's on our minds this week.

TG: Two weeks on from the US election and about six weeks away from year end. Where are we? Well, many of the trades put on before the election, anticipating Donald Trump's eventual victory, they have obviously performed well and enjoyed an extended run of positive returns, especially given he will enjoy full congressional support for at least the first two years of his term. A rise in the US dollar index this week would be the market's eighth consecutive weekly gain. That's a streak that not even Bitcoin or the sharply higher US yields we've seen over the last couple of months can match.

But rapid large moves such as these tend to create overbought or oversold conditions in markets. So it's natural to start to think about which of the so-called Trump trades has staying power and which might offer better risk reward in going the other way now. How much is in the price is the paramount question here. And discussing all of that this week with me, plus a few other assorted ideas for the year ahead, is Lee Ferridge. Lee is my counterpart in Boston. He runs the Macro Strategy team for the Americas, and he makes a long-awaited return to the podcast to share his current thinking.

Lee Ferridge (LF): Hello, sir. How are we doing?

TG: I'm all right. How are you doing?

LF: I'm good.

TG: Where have you been in the world, Lee?

LF: Where was I last? I was up in Canada last week. Before that, I was on the West Coast. I was in Philadelphia. I've been to New York. I've been to Mexico.

TG: You've been everywhere.

LF: I've been out to Canada a couple of times.

TG: That's good. Well, that's what we're going to talk about, I think. Okay. So you've been everywhere. And I'm just curious. We did this, I think, the last time you were on. If I'm not mistaken, we got kind of the vibe from the clients. And that's actually not really what I'm interested in. I'm actually interested in your thoughts. Those are going to be influenced, I suppose, by the discussions you have had with clients and done so many meetings.

I just wanted to get a sense of how you're feeling about the world. Big picture. You know, we're going to talk a lot about politics and the market reaction to that based on all of this work and all of the presenting you've done and the clients you've talked to.

How are you feeling about risk?

LF: I'm positive on risk. I mean, I think it's hard not to be, given the background, given the potential stimulus of policies we're going to receive in the early part of next year. You have central banks around the world easing rates when growth, well, growth in the US is holding up very well. It's not been as bad as people expected, I think, elsewhere or most other places anyway.

We see the same from real money investors. Generally, sentiment has been positive for a while now, certainly since the wobbles of the summer, they're getting rewarded by returns. So I think as we sit for now, then I am positive on risk generally. That's not to say I don't see problems in the future. It's my nature, it always is. But right now and looking into the end of this year and the early part of next year, yeah, I'm constructive on risk.

TG: The election has clearly been a further impetus for some of the risk on trades. Let's just use US stocks as the broad brush way of talking about that. But you have a lot of other views that have gained momentum. They were in place before Trump was confirmed as elected and before a red wave was confirmed as the political outcome.

They've continued since then.

I'm here, I'm talking about things like Bitcoin, the dollar, US rates pushing higher, the curve bearishly steepening in the US, with long end yields rising faster than short end yields.

Of these views, which do you think has the ability to last long? You talked about some bumps to come maybe, but which of them do you think has the staying power?

LF: I think the obvious one with the staying power is higher long end rates. I think the push higher in yield, the steepening of the curve to some degree, whether I prefer to look at fives, tens rather than twos, tens on that perspective. Again, looking ahead at all the policies that we have been promised and have been campaigned upon, fiscal loosening, trade tariffs, which will push up inflation, we can argue to what degree, but there will be an inflationary impact. And also what the proposals on immigration, which I think will be inflationary as well. So this is where I get to the idea of a steeper curve, and particularly higher long-end yields.

And we've been flourishing with 4.5 percent on 10 years, for most of the post-election period, we're still doing that now. I fully expect just to be moving through that in US 10-year yields over the coming weeks or so, before the end of the year, I think we'll be decisively through it.

TG: You mentioned looking at the shape of fives, tens, which has flattened over the last couple of weeks, and even since the election is maybe, well, it's probably about the same as it was on election eve.

In looking at that rather than the more orthodox view of the curve, say, twos, tens or twos, thirties, maybe even, why do you look at that particular part of the curve?

LF: I worry that not next year, and maybe not even year after, but at some point the US is going to go into recession. I think we're going to get a sugar rush of activity next year, through the tax cuts, etc., deregulation as well. But I worry the Fed is going to have to take more hawkish stance because we're going to get an inflationary reaction to that as well. So I worry that the market at some point is going to have to price again some sort of hard landing.

Two-year yields can go higher in that world. 10-year yields go higher because the fiscal element to it. Five years, the belly of the curve, I think is the bit that might have to start wondering about that hard landing. And this is why I'm sort of, you know, my preference right now is some of the things that I did, two fives, tens fly. So higher two-year yields, unchanged maybe five-year yields, higher 10-year yields.

TG: How likely do you see a hard landing scenario?

LF: I mean, having a hard landing now? No, we're not going to have one. But, you know, in 27, what would be my probability of a hard landing in late 26, early 27? I'm going to put that at, at least 50 percent, probably higher.

I struggle to, I worry that we're not going to get inflation back towards 2 percent without some sort of hard landing given, I didn't believe that inflation was going to drift all the way back down to 2 percent. I worry about the labor market more than most do from a perspective of, not the Fed perspective that it's weakening, but the perspective of the shortage of workers, the demographics, that concerns me anyway.

Then the results of the election mean I'm even more concerned about that. So I think we're going to have higher wage inflation, and I think the Fed is going to have to react to that, and that probably means, if the supply curve in labor has shifted, and will shift further because of the election, then we have to reduce demand for labor.

And if the economy is getting a sugar rush, then that means the Fed is going to have to probably be more hawkish than people expect, and that's where I get this idea of a hard landing eventually.

TG: I wanted to talk about the specific policies, and I'll start with immigration. I was actually going to do it last, but you just brought it up, and I think there's an interesting debate on, first of all, what effects it will have, but I just want to focus on the market aspects and how meaningful efforts might be in raising inflation.

How realistic are we going to see immigration reform that leads to significant shortages of labor that then push wage inflation? Can you quantify that at all?

LF: We're going to see a tighter immigration policy. We know that. We're talking about closing the southern border. There is talk about deportations.

Demographically, that could not come at a worse time. If you look at the domestic-born workforce, and again, you start in January 2020, and we go through to last month, the domestic-born workforce over that four years and 10 months has only grown by 450,000 people. That's two months' decent payrolls numbers.

The overseas-born workforce has grown by 5 million. That's where the workforce growth that we've seen has come from. So if we now reduce that immigration significantly, and maybe even go further than that, I worry about how do we continue to grow at a decent pace without growth in workforce if it's not to push up wage inflation.

Productivity is an answer. Most people accept that productivity growth coming from AI is still going to take a long time to come through. The recent productivity numbers have been more encouraging, but they don't fill that total gap. And this is where even two and a half years into the Fed hiking cycle, and into the cutting cycle, average hourly earnings are running at 4 percent year on year. The three month moving average is 4.5 percent. Your wage growth is easily outstripping inflation now, and this is boosting the consumer, and is one of the reasons why we have such strong growth.

But you come back to, you can see this tightness in the labor market. It's already here, and if things get tighter going forward on the immigration front, that has to lead to higher wage inflation.

TG: Could you also, though, see a scenario where demand is impacted to a degree that offsets that? Or if you're not growing your labor force at the same rate through immigration, surely you're also not growing aggregate demand.

How much do you think that might offset the pressures from wage inflation if you have lower aggregate demand?

LF: It's a good point, but if the wage inflation comes first, the existing population, their demand will go up because their real wages are growing. So, I mean, that's what we've seen more recently is you've got positive real wage growth and therefore, real consumption growth has been very strong. So, yes, overall, what you're looking at, but what you're talking about now is more of a stagflationary environment. You're talking about higher inflation and lower growth.

Now, does the demand fall sufficiently to offset the shortage of labor? Difficult one to say, but if you get wage growth first, which boosts the demand of the existing population, then demand overall won't fall sufficiently to completely offset that reduction in the population.

TG: Moving on to some of the other policies. This is a question I've been asked a couple of times, and actually, I think it got brought up on one of our team calls today, and this is the sequencing of trade policy vis-a-vis fiscal policy. As in, when do tariffs come in versus fiscal policy expansion being enacted by Trump and Congress?

I'm wondering if you have any thoughts on this, and how should we think about this sequencing, and what are the most pertinent risks to think about with respect to that sequencing?

LF: Well, I think in the sequences is trade tariffs come first. I mean, they can happen on day one, and they've been promised on day one. Do we get the full 60 percent on China, 20 percent on everything else on day one? None of us know. None of us know right now. Trade tariffs come very early on. I think that is clear, because that's executive order. It doesn't need Congress.

One would assume the immigration policy comes very early on as well. Again, a new immigration policy needs an act of Congress, but in terms of the southern border and the other proposals, they can be done by executive order as well.

The fiscal policy comes a bit later, because that will need to go through Congress. But don't think it's going to be delayed significantly. The Republicans have control of all three branches. So therefore, it can be done through budget reconciliation, which means the fiscal policy can be passed very quickly.

The question is, in a bit, I've been sort of, no one's really given me a good answer. Could he make the fiscal changes, the tax changes become backdated so they count for 2025? So if we're passing this policy in February, can he therefore implement the tax changes for 2025? And I think he can, because if it's that early in the year, I think he'll be able to implement them for 2025. So you could see a fiscal boost very quickly as well.

I think the thing is to accept is, President-elect Trump has a huge amount of power now, and he can put these policies in place very quickly. So the sequencing is important, you're right, but it's not like I think we're going to have to wait a year or two for the fiscal bit to come through. It's not, it's all going to come through pretty early on. 

Every appointment we've seen seems to be backing everything he said, and why not? He campaigned on the back of these policies, and he's won the White House, the Senate, and the House. So why not?

TG: So this brings up an interesting question, in that everything you've said so far, I think is pretty non-controversial, as far as exactly how you just summed it up. He won, there's a fairly broad mandate, and all branches of government are working in the same direction here. And the impact of that, I think, is also not controversial.

So what conventional wisdom that has emerged around all of this do you think is wrong? Where are markets going to be offside on this?

LF: I think they're underestimating the discussion we just had about immigration. I think the biggest one is they're underestimating the inflationary impact and how quickly the inflationary impact of the immigration policy will be.

Now the tariffs, the Fed could look through the impact of tariffs. Since it's a one-off tax, they can easily look through that and factor that out of their models.

The immigration, I think, hits more and it's not a one-off. You can't factor that out of the models. You can't ignore that. And so, the market, we've come a long way on rate pricing compared with where we were even a month or so ago. We only have three cuts priced in now by the end of next year. What about a hike next year? That's where I'm starting to lean now.

And you know, for a while now, I've been on more the hawkish side. I was always on the dovish side pre-pandemic and now I'm always on the hawkish side. We still have three cuts in. Why couldn't the Fed be hiking in the second half of next year? If the policies are as inflationary as we fear they are, and you get those fiscal policies early as well, which stimulates, you get sugar rush in for growth, why wouldn't the Fed be hiking in the second half of next year?

The market still has three cuts between now and the end of 25, which is way down on... Before they cut my 50 basis points, I think we had six in for next year. We're now down to three. Why can't rates be flat next year or even why can't there be hikes next year?

TG: And do you think the Fed matters unless that scenario comes to the fore where they need to think about a hike? Do you think at this point you've taken out so much that they really, they're almost on hold by default in a way. If let's say the Fed delivers another cut in December or January, which markets are pricing them to do, be more than halfway done with the easing cycle that they only started two months ago.

So unless you get that reheating scenario where they have to actually hike, do you think you've taken the Fed as far as you can in terms of pricing their activity?

LF: I would counter as have the Fed mattered all year really. I mean, not for the dollar, right? Not for the dollar. But for equity markets, have they mattered all year? Really? We had seven cuts priced in February for this year. They've delivered three. Equities have rallied consistently because the growth outlook has been so much better than we expected.

That's why the cuts were taken off the table. Not really because inflation disappointed. Because it didn't. It was more that growth was so strong that we thought the cuts are. So you look at equity markets this year, they've rallied as we've taken Fed break cuts out. So has the Fed really mattered this year in terms of asset markets? I would argue not. No, I don't think they have.

My scenario whereby they are actually hiking, I think, does matter. And I think that's the Rubicon. If we just continue to take out cuts, fine. We're taking them out because we're getting the stimulus of policy. Everything's great. We can continue to buy equities.

If we get to the point where they actually have to then actively try and slow the economy again, that's a different scenario. So no, taking out my scenario of hikes, if we just take out more cuts, does it matter? No, it doesn't.

TG: There you go. I got you to the right answer eventually.

LF: I got you to your answer.

TG: We got you to my answer, which is the right answer.

Thinking about Trump trades that you would fade, is there one of all the ones I mentioned at the beginning, just to bring this topic full circle, is there one that you think, this is wrong, I wouldn't go with this any further?

LF: If there is one that I think I would fade right now, it's probably the rally in small cap stocks. Small caps have generally outperformed on the idea that corporate tax cuts, trade tariffs are good for domestic producers, which they are. But I think what we're missing is a couple of elements.

One, trade tariffs will act as a negative for growth. So we've all looked at the positives in terms of fiscal stimulus, et cetera. They will act as a negative for growth. The immigration policy we're talking about, they might well be struggling to hire staff, and they're going to have to pay higher wages. And the final one is the impact on rates as we've talked about. Even if we don't have price hikes, if we take out these cuts, that's important for small cap stocks. And I think that's going to become ever clearer over the early part of next year.

TG: We've talked a lot about trades that have unfolded over the last few weeks, potentially unfolding into the end of the year a little bit more. But we are entering year ahead season. I think we're going to publish our year ahead piece in about two and a bit weeks from the time this podcast goes out.

But I wanted to start with a look back and think about what have you had to change your mind on this year? How have events forced your hand intellectually at least?

LF: I was bullish the dollar this year, and look, right now, it did work. But for most of the year, it was sort of sideways, and now it's about a little bit down. I think the bit that surprised me most of all this year was the lack of rate divergence. Now, it's coming through now, but for the first, say, 10 months of this year, the US economy performed as I expected it outperformed the rest of the world significantly.

It was the reluctance of the market to price interest rate divergence to a meaningful degree, even before the Federal Open Market Committee (FOMC) in September. We still have more rate cuts priced in for the Fed over the next 12 months from September onwards than we had for the ECB or the Bank of England or anywhere else. And that shocked me when, you know, US economy was clearly growing above trend, the economy was buzzing along, the Fed was, yes, they've cut since then. But the other economies around the world were slowing substantially, particularly in Europe.

And yet, we had, at one point, I think we had 150 basis points in for the Fed over the next 12 months and 75 basis points to the Bank of England. That bit shocked me and, you know, sterling as a result went up to about 134. That element there, the reluctance of the market to accept that we have significant macro divergence. We had it before the election, we're going to have it even more significantly post-election and finally post-election we're starting to price that. Or be it, we still have about the same for the Bank of England and the Fed over the next 12 months as we had in terms of where we go from here.

That bit surprised me and that meant the dollar was sideways, actually a little bit weak until probably six weeks or so ago. Now we're close to two-year highs, so it's happened in a rush, but I thought it would be more a gradual process. Because for the last 20 years pre-pandemic, yeah, rates did move together, largely in terms of change, maybe not in terms of level, but the central banks were very aligned. That's not going to be the case going forward, and the market really didn't want to accept that.

TG: Do you think the year ahead then is still going to be a rangy market for most things, or do you think we now have momentum, or do you think the factors that ultimately undo a lot of the positives short term you've talked about, create a range environment over the course of the coming year?

LF: I think we're going to have some momentum markets, momentum in one direction, then maybe momentum in another. Does that count as a range? I guess I didn't know how to define a range. I don't know.

TG: A big range, right?

LF: You could call it a range, but it's going to be a very big range. And I think we will have momentum. The trades we're seeing now, particularly in FX and in rates, will persist, I think, through at least the first half an extra. If we get to that scenario, I talked about Fed rate hikes, maybe you're going to further move in the dollar, but then we could start to see that reverse. So I think we're going to be more momentum markets next year. We were largely until the last few weeks, we were range markets this year, and now we've become momentum markets. I think the momentum market persists through next year.

I also think something we have to accept is we are going to see higher volatility. I mean, I think we are in a more uncertain policy environment in the US certainly. But then the reaction around the rest of the world, and then what's the economic fallout of trade tariffs from the US? What's the economic fallout of the policies we're talking about for the rest of the world? Europe obviously is a concern in terms of growth. The UK, we've just had the budget. Was it a fiscal tightening? Was it a fiscal loosening? Who knows? We'll find out.

But I think there is policy uncertainty increasing everywhere, and that has to lead in my mind to volatility. So big ranges, volatile, momentum, everything, all of the above.

TG: You can't be wrong.

LF: Exactly. Even better.

TG: Even better. Well, okay. So let's think about the extent of this. The dollar index, this basket of the dollar against the major currencies, is at 106.48. The range high over the last year and a bit is similar. We're there. So we break out there. We have, though, highs over the last five years.

When American exceptionalism in particular was a theme a couple of years ago, the dollar index got almost to 115, just shy, 114.

Do we test those new highs? Do we break, in fact, to highs above that 2022 high in the dollar index? Do you think?

LF: I'm not sure we get above that. I think we can retest it. I think we can get back towards that 115. But as I said, I worry about when we get to the second half of next year, if the Fed do have to hike, do we then start thinking about hard landing? Does the dollar then suffer on the back of that?

Because presumably, with others ahead in the rate-cutting cycle, you might actually start to see some green shoots elsewhere in the second half of next year because of the lower rates that will be in place and have been put in place. I'm reluctant to say we're going to see the dollar go above that 115 level, but I think we can get towards it.

A couple of things we have to also think about towards the end of next year perhaps, is one, the Trump administration's policy on the dollar. In his first term and certainly with Robert Nighthizer, potentially trade secretary or even treasury secretary, does want to have a weaker dollar because that's one of the purposes of the trade tariffs is to try and put pressure on the currencies to strengthen their currencies against the dollar.

The second one is, the fact that the first half of 2026 will see the end of Jay Powell's term as chair, Fed chair, and that's going to create uncertainty about who the appointment is going to be. I think it will be Chris Waller and if so, that's fine, safe pair of hands. If it's not Chris Waller, I wonder who it might be and people have mentioned Larry Kudlow and others, and I think that has the potential to upset the dollar as well. So look, let's say 115 for now. Let's revisit that towards the end of next year, but I think we can certainly have a run towards that.

TG: Very good. Well, last couple of questions, and I think possibly the most important question, what are you doing for Thanksgiving?

LF: I'm going to a friend's house for Thanksgiving, traditional American Thanksgiving at a friend's house.

TG: Very good. What is your favorite side dish?

LF: For Thanksgiving, see, it's not very American. It's more a Christmas thing. But I do like sausages on the turkey that are cooked on the turkey and then you have the sausages with the meal. I know it's not very American. I've been here 15 years, but I am still traditionally English. I do like those little sausages that go on the turkey and then you eat them afterwards.

TG: We've got bacon wrapped turkey coming up for us next week.

LF: You still do Thanksgiving there, don't you?

TG: Oh, we do it every year. Yeah, we're doing a big one this year, actually. We're doing two.

The meal on the day is a little smaller, but we are having a big Saturday party.

LF: Right.

TG: The correct answer, by the way, was sweet potatoes with bourbon mashed into them. That's the best side dish.

LF: Oh, I've never had that. That sounds good.

TG: Check it out. I don't know if we'll be doing an episode next week. So that might be the parting thought for everyone, is sweet potatoes with a little bit of Maker's Mark is good. Woodford Reserve is also very good. Mix that in with butter and brown sugar. Bob's your uncle as they say.

LF: Thank you, sir.

TG: It's been a pleasure. I will let you go. Thank you very much, as always, for your thoughts. It's a long overdue appearance on the podcast, and I appreciate you taking the time.

LF: Yes, it is.

TG: Yeah.

LF: Let's not leave it so long next time, Tim, if you can squeeze me into your hectic schedule.

TG: Well, we'll see.

Thanks for listening to this week's edition of Street Signals from the research team at State Street Global Markets. This podcast and all of our research can be found at our web portal, Insights. There you'll be able to find all of our latest thinking on macroeconomics and markets where we leverage our deep experience in research on investor behavior, inflation, risk and see you next time.