The Fed could cut rates in December and continue to cut in 2026: Guggenheim CIO

Key Concepts

• Government Shutdowns and Market Impact: The transcript discusses how government shutdowns, despite their political disruption, have not significantly harmed equity market rallies, with markets appearing to look past headline volatility.
• Trump Administration Policy Pillars: Four key policy areas are identified: trade and tariffs, deregulation, tax policy (specifically the "one big beautiful bill"), and immigration policy.
• Market vs. Politics/Policy: A distinction is made between market behavior and political/policy discourse, with markets focusing on fundamentals and Fed policy over headline narratives.
• Federal Reserve Policy and Data Dependency: The Fed's challenge in a data-scarce environment due to government shutdowns is highlighted, alongside their reliance on anecdotal evidence like the Beige Book.
• Bifurcated Economy: The concept of a two-speed economy is introduced, with a divergence between the lower-end consumer/small business market and the high-end consumer/large companies benefiting from trends like AI.
• Neutral Rate: The idea of a lower neutral rate (closer to 3%) is discussed, implying more room for rate cuts.
• Disinflationary Trend: Despite a slowdown in the rate of disinflation, the overall trend is still towards lower inflation, supporting further rate cuts.
• Fed Composition and Leadership: The divided nature of the current Fed is noted, along with potential candidates for Fed Chair and concerns about political pressure.
• Artificial Intelligence (AI) Investment: AI is viewed as a long-term technological game-changer, with current investment focused on infrastructure (chips, data centers, power). The risk of excessive debt for AI buildout is a concern, but not yet seen as a bubble.
• Credit Market Risk: A distinction is made between cyclical risk (late-cycle slowdowns, recessionary pressures) and structural risk (overleveraging, weakened covenants). The current environment is seen as more cyclical.
• Due Diligence in Lending: The importance of understanding underlying collateral and conducting thorough due diligence is emphasized, using the analogy of a Tiffany box filled with dirt.

Summary

Government Functionality and Market Volatility

Anne Walsh discusses the impact of government shutdowns on the market, noting that while they cause political disruption and headline volatility, they haven't significantly harmed equity market rallies. She views fiscal policy and political disruption as a recurring theme for the Trump administration, suggesting continued volatility. However, she believes markets are looking past this headline noise and focusing on fundamentals, including Federal Reserve policy.

Trump Administration Policy Pillars

Walsh identifies four key policy pillars of the Trump administration:

1. Trade and Tariffs: This remains an ongoing issue.
2. Deregulation: This is happening in the background, with initial focus on the "great pump in circumstance" and now more broadly.
3. Tax Policy: The passage of the "one big beautiful bill" has introduced certainty and is expected to create tailwinds into 2026.
4. Immigration Policy: Referred to as "reverse immigration," this is also a continuing factor.

Federal Reserve Policy and Economic Outlook

The conversation shifts to the Federal Reserve's challenges, particularly with inflation stalling around 3% and concerns about a weakening labor market. Former Fed Vice Chair Lael Brainard's perspective is shared, highlighting the Fed's divided stance on rate cuts.

Walsh believes the Fed is at a "delicate time" due to the government shutdown impacting data availability. However, she points to anecdotal evidence, such as the Beige Book, suggesting an economic slowdown to a more "equilibrium" level (sub-2% real growth). This leads her to believe that the neutral rate should be lower, potentially around 3%. She anticipates a rate cut in December, citing the Beige Book's indication of slowing and "fraying around the edges" in the economy. She also expects more rate cuts in 2026.

The Bifurcated Economy

A key concept introduced is the "bifurcated economy," characterized by two distinct speeds:

• Lower-end consumer and small business market: This segment is experiencing more sluggishness.
• High-end consumer and larger companies: These entities, with access to capital and benefiting from trends like AI, are performing better.

The Beige Book is seen as reflecting the broader, more sluggish segment of the economy.

Disinflationary Trend and Interest-Sensitive Sectors

Walsh argues that the sluggishness in the economy will help address inflation. She notes that interest-sensitive sectors, particularly housing, are slowing down, with housing costs declining. The owner-equivalent rent portion of CPI finally showing a downward movement is seen as a significant factor. While the rate of disinflation has slowed, the trend is still towards further disinflation, which supports additional rate cuts.

Federal Reserve Leadership and Independence

The discussion touches upon the composition of the Federal Reserve, acknowledging its current division. Walsh mentions potential candidates for Fed Chair, expressing a preference for those with an economist background. She names Kevin Walsh (a monetarist), Mickey Bowman, Kevin Hassett, and Chris Waller as strong contenders.

She acknowledges the historical instances of political pressure on Fed chairs but emphasizes the importance of Fed independence. However, she also reminds that the Fed is subject to congressional oversight and has a dual mandate of stable employment and stable prices. Walsh anticipates a more dovish Fed composition going forward, which she believes will be beneficial for interest-sensitive parts of the economy and the lower-end consumer. She also reiterates that tax benefits from the "one big beautiful bill" in 2026 will be stimulative, keeping the economy out of recession risk and leading to more neutral policy.

Artificial Intelligence (AI) and Investment Strategy

AI is identified as a major driving engine in the economy. Walsh views AI as a long-term technological game-changer but emphasizes that the market is still in its "early innings." Current investment is heavily focused on infrastructure: chips, data centers, and power. The broader application and usage of AI across the economy will take time.

Regarding potential AI bubbles, Walsh compares the current situation to the dot-com bubble of the late 1990s. She notes that unlike the internet bubble, where earnings were scarce, there are now earnings in AI-related companies. The primary concern is the potential for excessive debt accumulation to fund AI infrastructure buildout. However, she does not believe a bubble is imminent and sees more room for the market to run, with technology continuing to drive stock performance.

Credit Market Risks

Walsh distinguishes between cyclical and structural risks in the credit markets.

• Cyclical Risk: This occurs late in the economic cycle, with increased bankruptcies due to economic slowdowns and recessionary pressures.
• Structural Risk: This involves overleveraging of entities and weakened investor protections, as seen in the financial crisis.

She states that the current environment is more cyclical than structural, although she acknowledges that events like those at Tricolor and First Brands can raise questions. She is watching for widespread structural risk but does not see it at this point.

Analogy for Lending Risk

To illustrate the risk of reaching for yield in lending, Walsh uses the analogy of a Tiffany box: "you can take a Tiffany's box and it's beautiful and it's gorgeous and it put a pretty bow on it, but if you fill it with dirt, there's no diamond ring inside. It's just a box with dirt in it." This emphasizes the need for lenders and investors to conduct thorough due diligence and understand the underlying value of their investments, rather than being swayed by superficial appearances.

Personal Relaxation

When not working, Walsh enjoys reading and playing golf with her family.