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A Possible Storm
January 17, 2025
Rain can be either refreshing or destructive. It can make plants grow or produce devastating floods. But in all cases, it’s largely outside human control. Or is it?True, we have little control over whether rain will fall. We have a lot of control over how it affects us, though. Sturdy homes and good infrastructure can keep us safe and let us enjoy rainfall’s benefits.
Last week in my 2025 forecast letter, I predicted A Partly Cloudy Year, generally mild but with occasional storms. Today we’ll talk about the second half of that sentence. What could go wrong and lead to a worse-than-expected year? In short, what are the main risks to my forecast?
The biggest risk, in my view, is that persistently higher interest rates could do serious damage to both the government’s fiscal outlook and economic growth prospects.
Typically, as we will see, when the Fed starts cutting rates at the short end, the long end of the curve responds by also going down. The bond market seems to be reacting differently this time. We should note what’s happening—and why it’s happening.
The Time Came, and Went
Let’s examine the setup that brought us here. In September, the Federal Reserve began cutting rates. Inflation was not yet at the Fed’s 2% target, but officials believed it was headed that way.
On the negative side, the unemployment rate had crossed above 4% in May and kept rising to 4.2%. The “Sahm Rule” recession indicator had triggered, and other data seemed to be weakening, too. Given all...
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