Joe Keating’s Economic Outlook for 2025

INTRO: Helping community bankers grow themselves, their team and their profits. This is the Community Bank Podcast.

CALEB: We are coming to you from Atlanta—a snowy Atlanta, Georgia. You don’t get too many of those around here. This is the second full week of January. If you’re new to the show, thanks for joining us. This is The Community Bank Podcast, the podcast by bankers for bankers. And as we move further into 2025, we want to talk about the economic outlook for the year and for the first quarter. As always, we bring on Joe Keating. He’s a regular on this show. We bring him on pretty regularly to talk about the economy and his outlook for where things are going and what it means for you and for your bank, And as always, Tom Fitzgerald does a great job getting the best out of Joe. So, let’s get right to it. Here is Joe Keating and Tom Fitzgerald.

TOM: Well, Joe. I want to welcome you back to The Community Bank Podcast. I know you’ve been probably our most frequent guest, and it’s been a while. I think back to summer, I think. But again, I want to welcome you back to the show. And as we’re recording this, we’re all at our home locations. Joe is in Birmingham. I am in Atlanta, and we all have a coating of snow on the ground in the South, which as you know, usually shuts down the entire region. Joe, how are you doing and how are you dealing with the winter storm?

JOE: Tom, I’m great. Dealing with the winter storm by staying in the house. And one of the benefits though, is when you look outside the windows, it’s very pretty out there. I kind of reminds me of growing up in Chicago and the early part of my career in Michigan. It’s nice.

TOM: Yeah. Well, I grew up in Florida, so anytime we get white on the ground, it’s always a treat. So, it’s definitely, you know, it’s been a couple years I think since we really had any decent snow, but I think we’re getting quite a bit today, at least from the southern standards. So, anyway.

JOE: The youngsters are having fun with school being off.

TOM: Yes, that’s right.

JOE: For those that have slides, they’re probably out finding a hill.

TOM: Oh yeah, we’ve got some hills in our neighborhood. Yeah, they’re doing exactly that. So, I think Joe, was it the summer when the last time when we spoke a little bit on the economy?

JOE: It was Tom, and you know we talked about at the time that we really needed to see not only some data come, but we needed to see what the Fed was going to do, and maybe most importantly, you know what the outcome of the election was going to be before we really could sort of sink our teeth into what’s going on in 2025 and beyond. Although, as I’ll talk about a little bit, you’ll talk about a little bit, you know we’re just dealing with a lot of policy uncertainty at the moment because, while Mr. Trump won the election, we know where he wants to go on policy, but we don’t know what those policies are actually going to be. The devil is going to be in the details, right?

TOM: That’s right. So, let’s just kick it off. And like you said, you know, since we last talked, there’s been a lot of big events that have transpired dealing with, you know, not only the election, but the economy as a whole in the markets. Like you said, they brought a fair amount of volatility in the markets over the last two months really. So, kind of just give us your synopsis on what’s your take on the markets right now since the since the election and the results thereof.

JOE: Sure. Well, you know, President Trump’s victory carried small GOP majorities on both sides of Capitol Hill, as we all know, which will undoubtedly reshape the economic outlook for broad policy shifts on taxes, federal government spending, immigration, and trade, which will take place. Common stocks reacted very strongly to the election results, with a total value of U.S. stocks rising $1.6 trillion the day following the election. The fifth best one-day showing ever. The surge highlights the opportunities that investors are hoping will materialize with four years of tax cuts, deregulation, revival of deal making and domestic manufacturing, and strong economic growth supporting an elongated economic extension. While President Trump’s threat of higher tariffs presents some unknown level of economic risk, and the near-term impact of his administration’s policies on inflation, and the budget deficit bring a heightened level of uncertainty. Voters decided that the bigger danger was a repeat of the current Administration’s policies that resulted in the highest inflation in four decades and a record number of illegal immigrants entering the country.

JOE, continued: Additionally, the worst policy proposals, such as a tax on unrealized capital gains, or a tax rate on corporate profits that is uncompetitive on the global stage, have been taken off the table for now. Add in the Federal Reserve cutting rates another 25 basis points two days after the election and measures of both consumer and business sentiment soared. In response, S&P 500 rose 5.7% during December. A very strong return. However, after posting those very strong returns during November, common stocks were not able to gather any upward momentum during December. As investors digested the other side, which was a continued move in higher treasury yields, and they tried to determine the state of inflation as the data delivered mixed messages. Consider that the yields on two year and 10-year Treasury securities rose now during December another 8 and 40 basis points respectively, but they’ve risen another 11 and 16 basis points so far here in January. And they’re currently higher the two-year by 81 basis points and the 10-year by 110 basis points since the Federal Reserve cut rates back in September.

JOE, continued: High and rising treasury yields typically represent a significant headwind to common stock prices as treasury securities provide risk-free returns when held to maturity. While inflation remains well off the 40-year highs recorded in mid 2022, the reported inflation data remains above the Federal Reserve’s 2% target. And progress, it’s cloudy, but it appears to stall. The inflation data is messy, however, due to distortions from the shelter component and from several one-off items such as higher used vehicle prices due to the vehicles loss of hurricanes and higher egg prices from an outbreak of a fatal strain of bird flu. The year-over-year rise in the Consumer Price Index in November was 2.7%, a tenth higher than the October reading of 2.6%. While the core CPI rose 3.3% year-over-year and has been stuck between 3.2 and 3.3% for the past six months. However, when you just look at the six-month annualized rates of change, the CPI, the headlines at 1.9% and the core is at 2.2%. So, the data is messy.

JOE, continued: You know, going back to the shelter component, consider that if a real time rent measure was used in the calculation of the CPI, the Bureau of Labor Statistics reports that rent increases for new tenants were higher by 1% year-over-year in the third quarter. Core inflation over the past 12 months would be 2% rather than 3.3%, right in line with Federal Reserve’s targets. Investors also, during December and so far here in January, have tried to determine the most likely path forward for policy, as we kind of talked about before when we began, under the new Administration, particularly for immigration and trade. President-elect Trump has promised to close the southern border and deport illegal immigrants and raise or impose new tariffs on trading partners when he takes office later this month. Those policies could reverse 2 developments that have supported the disinflation trend over the past two years following good prices and slower wage growth. Of course, mid-month, the Federal Reserve signaled its intention to slow the pace of rate cuts this year amid worries that inflation progress has stalled at a rate above the Fed’s 2% target. And the economy remains remarkably strong. Finally, Congress wrestled with passing a funding bill to keep the federal government open past December 20, only averting a government shutdown when the House approved a stopgap measure to fund the government until mid-March at the eleventh hour.

JOE, continued: These concerns weighed on investor sentiment during December, leading to what I would refer to as a lack of buying interest for common stocks rather than a bout of aggressive selling. For instance, the S&P 500 declined 2.5% during December. And it is down maybe 1% given the drop this morning so far in January. Remember, however, that the S&P 500 basically matched its strong 2023 gain of 24.2% by rising another 23.3% in 2024, marking its best consecutive years since 1997. You know, in the aftermath of the data, the election, and Fed movements, we have seen a fair amount of volatility.

TOM: And I would say too, you know, typically when you get into a rate cutting cycle, you see the rates do exactly the opposite of what we’re seeing now. You know, rates tend to anticipate rate cuts and move lower, and we’re not seeing that. You talked about, you know, the increase in both the 10-year and the 2-year going the opposite direction, and that’s certainly even the case today as we record this. So, it’s definitely, you know, just like everything else in this cycle, it’s been a little bit different than what we’ve seen historically, which makes, you know, which makes kind of predicting a little bit more difficult since sometimes the historical precedents are not really working out in in the cycle. That seems to be the case again here in the most recent data that we’re getting. Just moving on, kind of you know, you mentioned the Fed’s intentions probably given that the stronger data that we’ve been seeing of late, that the pace of rate cuts is probably going to slow given what we saw from September through December. What are your thoughts about the outlook for the monetary policy stance of the Fed this year? You know, as we sit here today.

JOE: Yeah. Well, as you mentioned, Tom, we all know that in a widely anticipated move, the Fed lowered the target range by 25 basis points in December to 4.25 and 4.5. However, the committee’s forecast and Chair Powell’s comments at the press conference indicated that the initial phase of cutting rates is over. The policy rate has now been lowered by a full percentage point. Policy makers at the Fed acted with a sense of urgency over the last four months of 2024 to shift policy to a less restrictive posture. The Central Bank was trying to prevent past rate hikes, which took borrowing costs to more than a two-decade high, from pushing the economy into an unnecessary recession, which would have served no useful purpose. With inflation off the boil and making progress towards the 2% target and what over the summer was a moderate cooling of the labor market taking place, although that cooling is clearly in question following the last two months of job gains, including this morning’s report for December, which averaged 234,000, which by any measure is very strong.

JOE, continued: The December meeting offered a notable shift in the outlook for rate cuts this year into 2026. New projections show the committee expects to make fewer rate cuts, with the median forecast pointed to two cuts in 2025, down from four, which was the forecast at the September FOMC meeting, and only one cut in 26, down from two. Mr. Powell said the decision to cut rates again was a closer call than recent decisions, and that from here it is a “new phase, and we are going to be cautious about further cuts.” There were 12 voters, as always, at the December meeting, and there was one dissent, while three non-voting members of the committee indicated that the rate cut was not necessary. Given the strength in the economy and the lack of further progress in the various measures of inflation declining to the Fed’s 2% target, the Federal Reserve is going to pause the rate cuts for some period of time. A pause will give the committee time to review more data, assess the impact of the 100 basis points of rate cuts so far on the current status of inflation and the jobs market, and give them time to analyze the initial policies of the Trump Administration that will come into play.

JOE, continued: While the FOMC committee remains data dependent regarding future policy moves, it’s become policy dependent following Trump’s victory in the November election. The path to the 2% inflation target was pushed out to 2027 from 2026, in the latest summary of economic projections, and the committee now expects core inflation to rise by 2.5% this year, higher than this expectation in September of a 2.2 rise. More importantly, the Federal Reserve now sees inflation risks weighted to the upside rather than broadly balanced as it did back in September. Investors, not surprisingly, reacted very negatively to the outlook for fewer rate cuts with the Dow Jones Industrial average falling more than 1100 points following the rate decision. The S&P lost nearly 3% and the NASDAQ 3.6%. And the yields on 2-year, 10-year Treasury securities rose with respect. Each security rose by 12 basis points that day. There seems to be a sense on the committee that policy is not as restrictive as previously thought with the Trump Administration proposing a pro-growth policy agenda. Investor attention is now shifting from the outlook for interest rates to a focus on fiscal trade and immigration policies with the outlook for the economy now in the hands of the Trump Administration for the next couple of years. Big change.

JOE, continued: With the FOMC Committee and Chair Powell acknowledging that the path forward for rate cuts is more uncertain given the strength in the economy and worries that inflation progress has stalled above the 2% target, it would not surprise us if the Federal Reserve’s on pause for an extended period of time. Depending on how the proposed pro-growth policy proposals of the Trump administration play out, the Federal Reserve may be finished cutting rates unless the underlying inflation rate in the economy decline in a what I would refer to as a sturdy and persistent fashion or manner to the 2% target.

TOM: And that’s, you know, like you mentioned as we record this, we just received the December BLS non-farm payroll report, and it was unambiguously strong. And so, I wrote the same thing in my market update this morning, that this just pushes out almost any further rate cut until like you said, if we do get better news on inflation. I’m kind of suspect, you remember last year the first quarter, we had an uptick in inflation and some of that is I guess typically seasonally related. And so, I suspect we may see some of that again in the first quarter, which again would just push out any type of rate cutting expectation. And that’s why we’re seeing a negative reaction in equities, at least today and this morning. So, to me, yeah, it could be, I still think we’re going to see a rate cut this year, but I don’t know that that’s going to come in the first, certainly not the first quarter. But maybe not even in the first half.

TOM, continued: But let me ask you this. You talked about that the policies probably weren’t quite as restrictive as the Fed thought when they when they estimated the neutral rate at 2.5% prior to 24. Now they’ve gradually been nudging that neutral rate estimate up. The last Dot plot showed it about 3%. Do you think we’re going to continue to see that estimate of the neutral rate continue to edge higher, which would imply that at the current level of the funds rate, we’re not quite as restrictive as we would have been if that neutral rate had stayed sort of in that 2 range?

JOE: Yeah, I totally agree with that Tom. And you know, thinking about the rise in in Treasury yields, you know, I continue to view what I’ll refer to as a somewhat remarkable rise in treasury yields since the Fed cut the target range for the federal funds rate by that larger than expected 50 basis points back in September. As the most surprising and potentially alarming recent development in the financial markets, a lot of factors I think are behind the rise in treasury yields. Stronger yield growth. Worries that inflation progress has stalled as, as you mentioned. Concerns about the federal budget deficit and the massive supply of new issue treasury debt that need to be sold. And as we’ve talked about, the Federal Reserve signaling that additional rate cuts are likely to be more cautious and gradual. All these things combined to push the yield on treasury yields higher during September and so far, here again into January. The yield on the 10-year Treasury note during December rose 40 basis points, and it’s risen another 16 basis points so far here in January. Now we’re 110 basis points above the yield the day before the September FOMC meeting. What’s really interesting about that 110 basis point rise is that the vast majority of, the markets are currently updating, it looks like the majority of that rise was in real yields as opposed to an increase in inflation premium.

JOE, continued: There was, you know, about maybe a 2.3 … or the inflation premium is maybe up to about 2.4%. But the vast majority was due to an increase in real yields. If you take a look at the increase in 2-year Treasury yields, it’s a little different. It’s more evenly split between an increase in inflation expectations and an increase in real yields, and I think maybe part of that is due to this anticipation that there might be some tariffs put in place. Which, you know, what history tells us is that tariffs are not quote-un-quote inflationary. They’re a one-time adjustment in in the price level, but nonetheless we will see higher prices if they go into affect. And I think that’s why the inflation expectation of the 2-year has been—the increase in it has been larger than what we’ve seen in the 10-year. You know, going back to the relationship between treasury yields and the Fed, as you got to mention Tom, the yield on the 2-year Treasury note is only two basis points below the 4.38% midpoint of the current target range for the federal funds rate.

JOE, continued: So, the market is not expecting any further drop in the target range for the federal funds rate. And I think this is consistent with our view that the Federal Reserve is about to pause and that the Central Bank could be on pause for an extended period of time, as you just mentioned. And in fact, depending on how things play out, you don’t think that could be finished. You know, looking at the history of treasury yields in what I would refer to as a steady state environment, the yield on the 10-year Treasury note tends to settle in at a level near the growth rate of nominal GDP. So, if we had an inflation rate and a real growth rate both in the range of 2 to 2.5%, you know, that’d be consistent with a yield on the 10-year Treasury note in the range of 4 to 5%, which covers the current yield, which I think is about 4.76% at the moment. So, where the yield on the 10-year Treasury note trades in the next year will be determined by how the policy proposal the Trump Administration unfolds and how they impact the economy, inflation in the outlook for the budget deficit.

JOE, continued: This is an unusual amount of uncertainty than what we typically deal with because we have a broad array of policies that are going to come, and we don’t know exactly what they’re going to look like. While there is currently no sign of the rise in the yield on the 10-year Treasury ending anytime soon, largely to all that uncertainty regarding policy that I just mentioned, its impact on inflation, the budget deficit and the national debt. The real yield that is, you know, subtract inflation expectation out of that nominal yield, is becoming increasingly attractive. It’s up at around 2.4% on the 10-year Treasury note. And you know you can get average real yields on 10-year treasuries in a number of different ways, different timeframes, different measures of inflation being dropped out of the yield, et cetera. But you know the average tends to run around 1.5%, let’s say, real yield. There are periods of time where it’s a little below, periods of times a little higher. But that 1.5% average real yield is a fair amount below what we’re seeing right now in terms of about 2.4% that the implied real yield is in the market. So, at some point, I think investors will begin to find the treasury market to be attractive, but a lot of lot of caution currently.

TOM: Yeah. And I would just add too, you know, the increase in yields that we’re seeing here is really a global phenomena. You’re seeing that in the UK, you’re seeing that also in Europe, and those economies are not nearly as robust as the US. And so, I don’t know if we’re getting back to the revenge of the bond vigilantes or not, but definitely this higher yield scenario is a situation that not only we’re going to have to deal with domestically, but it’s going to be a global phenomenon as well. I can’t let you leave, as always, Joe, without getting kind of a view on equities and the stock market. You know we’re sitting here, we’ve had back-to-back 20% gains in the S&P 500, and if you look back in time, that has occurred four times really since World War 2. And the returns following that. So, in the third year you’ve had returns of 2.6%, let’s say in 56. 31% and 97. 26.7% in 98. And 19.5% and 99. So, even after two years of 20% plus gains, it seems like more often than not, you’re still going to follow that up with a fairly strong gain in that third year. You know, just kind of tying it all together. What is your outlook for the economy and the common stocks this year? Given where we’ve come from the last couple years and what we’re likely to face as far as higher rates and the new Administration in this next year and the next few years to come.

JOE: Yeah, well, you know, it’s interesting how when you look at that range of quote-un-quote, third year returns after the two consecutive plus 20% gains in S&P 500, what really determined the gain in the subsequent year was the growth in the economy and therefore the growth in earnings. So, as 2025 unfolds, we think the backdrop for common stocks looks positive as a couple of the trends of power common stocks higher over the past two years remain in place, while others have largely played out, but do not appear to be poised to reverse and become headwinds to stock prices. However, as you acknowledged and we both kind of talked about this, the New Year brings a new round of policy uncertainties that will only clear up as Congress and the Trump Administration decide on a wide range of policy proposals. The economy looks to have grown at a pace in 2024 to pace in about 2.7% and enters 25 with a +4 momentum, supported by a still a solid, maybe one could say accelerating jobs market, steady income growth that is handily outpacing inflation, strong productivity gains, business and consumer confidence that’s rising, and healthy business capital spending, spurred by artificial intelligence related investments.

JOE, continued: You know, we continue to expect that the economy is on track for an elongated cycle, helped along by the surge in both business and household sentiment post-election and the business-friendly policy agenda that President-elect Trump is bringing to Washington. Operating earnings for companies in the S&P 500 are expected to grow roughly 15 to 16% this year, according to the analyst at Standard and Poor’s, and because of the economic expansion remaining on track and those further gains in productivity. While the recent inflation data has not been uniformly reassuring at face value, with the year-over-year reading closer of the 3% rather than the 2% target. As we mentioned, digging into the reports and if you take a look at the November read on the core PC inflation, they indicate that the disinflation trend of the past two years has not reversed, but has clearly moderated. With the path to 2% not proving to be linear or tidy, it concerns that certain policies of the Trump Administration could keep inflation stubbornly high. Interest rates and bond yields will likely remain higher this year than expected just a few months ago, and obviously we’re seeing that.

JOE, continued: Despite inflation potentially remaining above the 2% target for the next year or two, we are not looking for a rekindling of inflationary pressures as one off items like the used vehicle prices or egg prices will filter out of the data. And the shelter inflation, that component has started to slow and is expected these further as newly signed rental leases continue to roll into the data series. Additionally, motor vehicle insurance inflation looks to be stabilizing as the outside gains over the past three years have caught up to the increase in vehicle prices, and the Federal Reserve remains committed to positioning monetary policy to eventually bring inflation down to the 2% target. As for monetary policy, I already mentioned that would not surprise that the Federal Reserve is on pause from extended period of time may be finished. An interesting observation is that common stocks tend to perform better when the Federal Reserve is gradually lowering rates rather than aggressively cutting rates, because that means the economy and financial markets are not under stress. Which would require a markedly easier monetary policy in short order. In that regard, the cautious shift, which could now be potentially viewed as a pivot in the rate outlook by the Federal Reserve at the December meeting, could be viewed as good news for the outlook for common stocks. So, bottom line for us, we think common stocks look to still have the wind at their back and not in their face.

JOE, continued: However, the markets are dealing with the fact that changes in the wind. With President-elect Trump returning to the White House with many campaign promises that he will attempt to fulfill, leaving businesses in the markets to figure out how the looming policy initiatives will alter the outlook for investment, growth, and inflation. Likewise, as we’ve talked about, the Federal Reserve will need to navigate the eventual set of policies passed by Congress and what that will mean for growth and inflation. So, to me, the bottom line for stock market is that the returns on common stocks this year will be determined by a tradeoff between higher Treasury yields and the ability of corporate America to deliver meaningful gains in earnest. Add in the Federal Reserve turning more cautious at the December meeting, and we do not expect any further price earnings ratio expansion in 2025.

JOE, continued: We expect that earnings will determine the path for stock prices this year. I continue to think that the aggressive rise in Treasury yields from the lows recorded in mid-September and the possibility of yields rising further as the biggest risk to the stock market over the next couple of months. And we’re clearly seeing that and saw that during the month of December and so far here in January. The major risk to stock prices over the next year or so would be the Federal Reserve needing to shift policy to a more restrictive stance to fight a rekindling of inflationary pressures, which would likely reset common stock prices lower. When the common stocks suffer, they’re almost certain you know 5 to 10% decline sometime this year. You know, it’s interesting, you look back in history, we always have a 10% decline, and we tend to have about 7 3% to 5% declines during the calendar year. We think a growing economy, pro-growth policies, strong earnings, inflation being within a band of 2 to 3%, and a Central Bank that will only guide rates lower as inflation eases further should allow common stocks regain their upward trajectory. At the back should a near term bout of volatility and selling pressure, kind of what we’re experiencing right now, hit the market. I mentioned the buyers strike for common stocks that arose during December and so far here in January, there’s been no signs of a real accumulation of either stocks or bonds has emerged. So, we wait patiently to see exactly how the financial markets will play out here in 2025.

TOM: Yeah, maybe the case where, like you said, we sort of kind of sit and wait in the first quarter to see where these Trump policies that get put into place. You know, which ones actually do get put into place and then you kind of go from there as to kind of resetting the expectations going forward. And so, right now the markets kind of balancing between, okay, we’ve got inflationary potential from these policies, but we also have growth potential. And so, you know which one is going to be the greater, and so, that’s the uncertainty I think that we’re dealing with. That the investors are dealing with right now. But that will kind of that will clear up I think as we start move through the first quarter and the first half of the year. And then you know, I would think that like you said, there’s still potential for decent gains. You know, maybe not that 20% category given that that was a lot of expectation of rate cuts that’s probably not going to happen, but, you know, at least the earnings gains and what you talked about, the productivity that you can get these outsized improvements and not have that inflationary impulse to them because of the increase in productivity. I think that all that is, you know, the potential of what we’re trying to figure out as we go through the course of 25. And I think you know the first quarter certainly is going to be a period of sort of just feeling that out. And then the second quarter, you start to get a better feel, and then as you move to the second-half of the year you really start to get a better degree of confidence in which way that’s heading. I think that’s kind of where we’re going to be sort of settling in as we move through 25. Is that kind of similar to what your view is?

JOE: Tom, I totally agree with that. And I think that’s a great summary of what we’re looking at in the financial markets as 2025 unfolds here.

TOM: Well, great. Well, Joe, I want to thank you again for your time and you know, keep safe in this this weather and enjoy the snow. And I’m sure we’ll get back together in a few months to kind of rehash. Maybe you’ll have a few more answers from, you know, from some of these questions that we have today and kind of get together a little with more certainty on where we see 25 heading. So, thanks again. I appreciate your time and all of your insights.

JOE: Thank you, Tom, and have a great day.