High deficits and tariff uncertainties dominate the market in the second half of the year; the change in Federal Reserve Chair may trigger volatility

As the second half of 2024 unfolds, the financial markets will continue to be dominated by high fiscal deficits and uncertainties surrounding tariff policies, while bond yields are expected to maintain their role as the "steering wheel," continuing the intermittent dominance seen in the first half of the year.

However, market volatility may rise again in the summer after June. Investors will begin to focus on President Trump's upcoming announcement of the next Federal Reserve Chair. Although the current Chair, Jerome Powell, does not finish his term until May 2026, Trump is expected to make personnel appointments significantly ahead of schedule.

Trump has repeatedly criticized Powell's policies on interest rates, especially following the release of the latest inflation data this week, which came in below expectations. The data showed that the U.S. Consumer Price Index (CPI) rose 2.4% year-on-year in May, lower than market expectations, prompting Trump to reiterate his call for significant interest rate cuts.

Powell, on the other hand, has maintained a wait-and-see attitude, stating that the Federal Reserve is waiting to see if inflation will rise again.

According to the Zhitong Finance APP, Greg Peters, Co-Chief Investment Officer of PGIM Fixed Income, stated that an early appointment of the Federal Reserve Chair is "extremely rare," and such a move could lead to increased market volatility, pushing the long end of the U.S. Treasury yield curve upward. He pointed out that since the Federal Reserve is "an extremely important institution," any unusual appointment could have "long-term effects" on the market.

However, Peters also noted that the Federal Open Market Committee (FOMC) is composed of seven members, and the Chair only has one vote. He added, "The market generally believes that whoever takes over the Chair position will tend to support interest rate cuts."

Potential candidates viewed by the market as possible successors to Powell include former Federal Reserve Governor Kevin Warsh, Director of the National Economic Council Kevin Hassett, and current Federal Reserve Governor Christopher Waller. Foreign media reports suggest that Treasury Secretary Scott Bessenet may also be considered.

It is reported that Bessenet indicated to the media before last year's election that Trump might announce Powell's successor ahead of schedule, and even if that person has not officially taken office, their views and predictions could have a substantial impact on the financial markets.

Bessenet noted, "The market will closely examine who this person is, what they have done in the past, what they have said, and even their comments during the candidacy period, all of which could trigger volatility."

The upcoming Federal Reserve meeting is expected not to adjust interest rates, while there remains significant divergence in the market regarding when rate cuts might begin. Rick Rieder, Chief Investment Officer of Global Fixed Income at BlackRock, believes that if the economy continues to perform poorly, the possibility of a rate cut in September still exists.

However, economists at Bank of America predict that rate cuts may not begin until next year. According to their analysis, moderate inflation and the addition of 139,000 jobs in May have alleviated the risk of "stagflation." "This means that the labor market does not appear weak at the moment, avoiding panic-driven 'bad rate cuts.'"

They further pointed out that the Federal Reserve may have to wait until 2026 to take action in the context of "robust employment and gradually declining inflation."

Nevertheless, Rieder expects that economic growth in the U.S. will be very slow in the fourth quarter, but if tariff uncertainties ease, growth is expected to accelerate again. Trump has previously indicated that he may raise tariffs on July 9, but the countries currently in negotiations may have the opportunity to extend the deadline Besenet also stated this week that there may still be room for negotiation.

Currently, the United States and China have reached a preliminary agreement on imposing a 55% tariff. Rieder believes that as long as the tariff levels stabilize, the market can gradually adapt: "As long as businesses know where the tariffs are, they can operate."

Meanwhile, the U.S. Congress is negotiating a tax reform bill. The version passed by the House of Representatives last month is expected to add $2.4 trillion in deficits over the next decade. According to the Congressional Budget Office (CBO), by 2026, the deficit as a percentage of GDP is projected to rise to 7%.

In the face of such fiscal pressure, the bond market may experience "periodic spikes in yields." However, as funds flow into higher-yielding assets, these yields may eventually retreat. Rieder noted, "There is still a lot of cash in the system, and I believe yields will remain within a certain range."

He expects the 10-year U.S. Treasury yield to fluctuate between 3.75% and 4.625%, and this benchmark has a broad impact on mortgage and other credit rates. If this yield rises rapidly or experiences significant volatility, the stock market may also be affected.

George Goncalves, head of U.S. macro strategy at Mitsubishi UFJ Financial Group (MUFG), also believes that the 10-year U.S. Treasury yield will hover between 4% and 4.5%. He emphasized that economic growth is slowing, and a weak labor market will increase pressure on the Federal Reserve to cut interest rates. He questioned, "If that's the case, why wait?"

Goncalves pointed out that the Federal Reserve has been slow to act mainly due to concerns about a rebound in inflation. But he also stated, "This concern may be misplaced."