Top of the Morning: POTUS 47 - Affordability, Monetary policy

Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.

For today, we will continue with our series of POTUS 47 conversations as we do on a monthly basis. That means we are joined here once again by Kurt Reimann, fixed income for the Americas with the UBS Chief Investment Office. Kurt, thank you for dropping by on this Tuesday.

Nice to have you back with us. Thanks, Dan. Hard to believe 2025 is almost at a close here.

Good to be back with you. Yep. And a few topics here we want to update our listeners and clients on before we close out the year.

Though up front, as always, I do want to remind you, our listeners, that all coverage by the Chief Investment Office as it relates to POTUS 47 in the form of updates, publications, is made available for you on the website, UBS.com forward slash POTUS 47. So let's move into our conversation for December, Kurt. Over the past couple of months, the Trump administration has been increasingly vocal about improving affordability for Americans.

Now, from a policy standpoint, how could the focus on affordability shape President Trump's 2026 agenda? Yeah, you speak of the last couple of months, but I go back to the 2024 election when affordability was a top concern among voters. And you could also maybe argue that some of the expectation coming out of the election was that affordability and inflation would be a top priority for the administration and that maybe today we'd be sitting here with not just lower inflation, but even potentially lower prices.

Because it's not about the change in prices for Americans, it's about the level. It's about going to the store or getting your insurance bill and just seeing the sticker shock. Here it is, it's almost 2026, and this issue hasn't gone away.

If you look at polling data, a share of Americans who disapprove of the president's handling of the economy is almost 15 percentage points higher than those who approve on inflation, this affordability question. The approval deficit is 27 percentage points, and both of these, economy or inflation, are larger than the president's overall job approval deficit. So I think this has something to do with tariffs.

That's been a key part of the administration's policy agenda during 2025. These are attacks on Americans, and they increase the price of everyday items. Because if you look at companies, they have mostly passed the tax onto consumers rather than letting it take a bite out of their profits.

As a result, we've got headline inflation that's closer to 3%, it's not closer to 2%, it's still higher than most Americans would like. And that's kind of interesting because even with the pace of average hourly earnings running at close to 4% year on year, that gets you a real wage gain of around 1%. But that doesn't change the fact that Americans feel like their incomes are getting squeezed because of the cost of housing or insurance or groceries, electricity, and so on.

So when I think about the year ahead, we do have the Supreme Court decision on the bulk of the administration's tariffs, that's this International Emergency Economic Powers Act, could arrive soon. If it doesn't happen on this Thursday, it's probably not going to happen until the new year. But if those tariffs are declared illegal, this could send something on the order of magnitude of, call it $140, $150 billion of government revenue back to the companies who paid the tariffs, and then those companies could decide how the windfall might be potentially shared with consumers.

I don't want to give the impression that this is easy, it would be a logistical mess. But in theory, there could be some benefit to Americans. And then how the administration reacts to the decision with potentially new tariffs is important, especially during a midterm election year, when most of the pundits think that there's a high likelihood that the Republicans lose unified control.

And then you've also heard recently the administration floating the idea of sending checks to Americans to ease the pain of the tariffs. There's also plans to aid farmers that were hurt by lost revenue from exports to China. More aid to farmers could be on the way next year.

One of the other areas outside of tariffs is on housing. That's been a vexing issue, and the affordability question can't be solved overnight. Mortgage rates, you know, we think those could decline some, but in a world where inflation is stickier and we have moderate economic activity, it's not like we're going to get mortgage rates back down to, you know, early post-COVID eras or in the world after the financial crisis.

Rates are higher, they're structurally higher. The Fed's cutting interest rates and it's not having that much of an effect on long rates. So there's really no easy fix from the rate world and bringing new housing online, which is anyway highly influenced by state and local governments.

And the issue of NIMBY isn't also, you know, kind of a 2026 cure-all. And then we think about, you know, the cost of materials is higher because of tariffs, the availability of workers is reduced because of tighter immigration. So, you know, I think if we were to maybe just kind of round out this question, if there were quick fixes to affordability, we probably would have seen the administration take action on that by now.

So, you know, what can the president do on his own? It's probably something in the order of, you know, thinking about maybe not increasing tariffs a lot if the Supreme Court declares them illegal, or if they do raise tariff income, then using that income, you know, to then send it back out into the economy. So those are some of the thoughts, at least, of what the administration has in its control.

Well, a lot of considerations there, and it does sound like the IEPA ruling by the Supreme Court will be critical, and perhaps we'll have more clarity on that over the next few days, as you indicated, Kurt, as a possibility. So I do want to talk about Congress in terms of the kind of role Congress might have in delivering an affordability-focused agenda in 2026. What might some legislative initiatives consist of, and is there anything along these lines currently in progress?

Yeah, let me take that second part of your question up in a bit, because I think that's the most important. But, yeah, as far as, like, you know, what can you look to, you know, Congress seems to have punted on health care reform until next year. It may even take longer to come up with a set of policies that even just Republicans can agree to if you think, perhaps, that they would move some solution through on reconciliation, where they wouldn't have to do a bipartisan solution.

So I think we can assume that next year Affordable Care Act insurance costs are going to rise for roughly 20 million Americans with the expiration of the enhanced premium subsidies, and many are going to be unable to afford the higher premiums and will lose insurance. So that seems to be pretty well baked in for the first part of 2026. And then another area that could be instrumental to, and I'm thinking about energy and electricity costs, you know, Congress has long agreed on the need for permitting reform to aid in infrastructure and energy development.

But our colleagues in the U.S. Office of Public Policy, they point out that the how is often much more difficult than the what, and permitting reform has been on the agenda for years, but it's just not clear what's going to break the log jam to achieve a bipartisan compromise. And here you do have to get Democrats and Republicans working together because it's not something that's going to easily work its way through this process of reconciliation.

So that seems stuck at the moment. And meanwhile, energy costs, electricity costs in particular, you know, continue to outpace the overall rate of inflation. And the transmission and grid bottlenecks are complicating power availability at a time of high data center consumption related to AI.

This issue is not going to go away. If anything, it's going to become more important in a midterm election year. And you've already heard about it being discussed and being important in the outcomes of recent state elections.

And it definitely moved its way into the mainstream media discussion. But I think it's fair, this is the second part of your question, to ask what questions, what actions have already been taken to assist with affordability, but maybe so far felt invisible. And here I point to next year, many Americans will find affordability partially improving because of the changes to their individual income tax withholding that is already backdated to the start of 2025.

And so they're going to get a higher rate of withholding for 2025. And that means refunds in early 2026, when those that were paid in income from overtime, or tips, or were over the age of 65, likely going to get large refunds, because the tax rates that were enacted in the tax cut legislation, signed into law over the summer, are lower. So this may solve some of the affordability concerns.

Americans will either use the refunds to pay for consumption, or pay down debt. And the scope for further spending or tax reforms to alleviate affordability from here, I think that's limited. And the reason being that we now have already high deficits in the range of call it six to 7% of GDP annually out over the next, you know, the foreseeable horizon, and a debt load that's on a path to 40 trillion.

So I think we just have to see how the, you know, the act changes the affordability. That's something that Americans haven't yet really seen the effects. But we do think it's going to provide a bit of a pickup to economic activity in the early part of next year.

And so we'll just we'll see how that translates into, you know, the President's job approval rating and the odds of Congress, either staying unified or shifting to divided. But I think that's going to matter a lot in the in that calculus as Americans go to the poll in November to vote for their new representatives in Congress and the third of the Senate that's up for reelection. Well, it will be interesting to see how this all takes shape in 2026.

And as you pointed out, Kurt, that leading up to the midterm elections next November. So one more topic to cover. I do want to spend a few moments here on the Fed because we are coming off of the December FOMC meeting.

We did see the Fed cut rates by 25 basis points, an outcome which CIO was expecting heading into the meeting last week. Now, against the backdrop of a new Fed chair, likely in the spring, it has been reported that perhaps we will learn a name of a nominee from President Trump in the weeks ahead. And that all coupled with current economic conditions.

What are CIO's expectations for monetary policy in 2026 or at least through the first half of the year, Kurt? Yeah, I think this this one's easier to just kind of in a nutshell answer. You know, personnel is policy.

And as you say, we'll have a new Fed chair announced, confirmed, taking the role in 2026. The composition of the FOMC could change even more depending on the outcome of the Supreme Court case brought by Elisa Cook. But, you know, even though policy rates have moved into and Fed chair Powell described this last week into this neutral range.

And so the scope for cutting rates will be lower or reduced. The bias remains towards at least one more rate cut in 2026. The market's expecting two.

Of course, that's been moving around a lot. And this is based on three factors. We've got likely some, you know, easing or maybe growing weakness in the labor market, a likely topping out of inflation, not back to the Fed's target, but just not rising further.

And a Fed chair that's pretty likely to move in the direction of the Fed's own estimated longer run policy rate of 3%. And that easing bias is also reflected in the Fed's decision to purchase assets at the front end of the Treasury yield curve to alleviate some strains that they were seeing in short term funding markets. So, yeah, very much part of our base case for next year is a Federal Reserve that is still cutting, maybe even moving towards easing of monetary policy.

And that's a central component of our generally favorable view on risk assets, as well as our belief in the bond market that it's going to be a year of what we call carry or effectively the coupon income. Not a whole lot of scope for price increases on bonds because rates have already come down. They're pretty close to our target.

There may even be episodes during the year where rates rise, and it's feeling a little bit difficult. But on balance, we think this is a year where it's an income or carry year, helped in part by the Fed cutting rates. Now, this last bit, I just want to say, too much could be a problem.

So, if the Fed cuts rates by more than the financial markets think is warranted for achieving still stable inflation, then that could complicate rates, especially out the curve, longer maturities. So, that's going to be the balancing point, is that in order to get rates lower, inflation data has to behave. It has to also indicate that it's topped out, it's moving lower.

If it doesn't and the Fed's cutting rates, and this is something that we have to be mindful of, is that long rates could really take notice. And instead of rates falling by year end, we have a different outcome of rates moving up and perhaps even more than or offsetting the income. That would be a big move, but just have to be careful about our maturity exposure even still.

And not assume that there's this one-for-one relationship where the Fed cuts rates, and lo and behold, long rates fall. It's not as easy as that, given that we are closer to that neutral range and inflation is on, relative to what the Fed would like, is on the high side. Well, Kurt, the conversation will, of course, continue into the new year, though.

Thank you, Kurt, for all of your contributions and time spent here on the series with our listeners and their clients here in 2025. Thanks, Dan. Thank you, Kurt.

And again, today we have been joined by Kurt Reimann, head of fixed income for the Americas with the UBS Chief Investment Office. Again, as a reminder to you, our listeners, our clients of UBS, updates on CIO's continuing coverage of POTUS 47 are made available for you up on the website, ubs.com forward slash POTUS 47. There you can locate all of the related resources and materials.

From UBS Studios, I'm Dan Cassidy. Thank you for joining us. Thank you for tuning in.

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