Stimulus Or Strain? The Dual Faces Of Deficit Spending

January 13, 2025

One of the small surprises in the last couple of months came with the December meeting of the Federal Reserve’s rate-setting arm, the Open Market Committee.  The Fed dropped its short term rate target by one-quarter of a percent (twenty-five basis points in investment lingo), bringing its 2024 target a full point below where it began the year.

The Yield Curve Explained

At the same time, however, the Committee sharply pulled back its previous expectations for further accommodation in the new year.  This took markets by surprise and, despite the immediate reduction, long term interest rates rose sharply and ended 2024 close to their earlier peaks.  The year ended with short term rates well below longer term maturities for the first (extended) time in a couple of years.

This configuration is known as a ‘normal’ yield curve – rates start low and rise as time to maturity lengthens.  The logic is simple.  The longer the maturity, the higher the risk of unknown and untold events, thus a higher reward required by investors.  

Treasury yields continued to climb early in 2025 and jumped further following Friday’s strong employment report.  Earlier in the week, the Fed released the minutes of its December meeting.  As anticipated, concerns were expressed about stubborn inflation and strong economic growth.  The minutes confirmed what Chair Powell discussed in his press conference – economic activity and price pressures do not justify additional stimulus from monetary policies.

Weighing In on Deficit Spending

The elephant in the room, however, is fiscal policy.  In the short term, deficit spending is stimulative, and the federal government’s $2.0 trillion deficit is doing just that.  While that is outside the Fed’s bailiwick, there is no question that government spending weighs on the thoughts of monetary authorities.

The federal deficit is now over one-quarter of all federal spending.  The interest alone on our accumulated national debt is approaching $2.0 trillion annually.  With the uncertainties of tax policies and tariffs, it’s no wonder that the Fed is moving with more caution.  Likewise, there is no surprise to rising long term yields – risks are rising daily.  Former Defense Secretary Donald Rumsfeld once referred to the concept of ‘known knowns, known unknowns, and unknown unknowns’.  We’re clearly in the latter category, and clarity is some time away.

For more background on our views and plans, please take a few minutes to read the Winter Economic & Market Commentary.  And, as always, please be assured that your wealth is being managed conservatively, with a core focus on diversification and valuation. Contact us today with any questions you may have regarding your investments. Opportunities abound, even in challenging times, for prudent investors.  We are here to take advantage of them for you.  Your success matters to us.