A week ahead of inauguration day, Scott Colbert, executive vice president, director of fixed income and chief economist at Commerce Trust, takes a look at how the Federal Reserve and the economy will fare in President-elect Donald Trump's second run in the White House. Join us live at 11 a.m. on Jan. 16 to hear Scott's outlook and what bumps may need smoothing.
Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Gary Siegel (00:00:10):
Hi, and welcome to another Bond Buyer Leaders Event. I'm your host Bond Buyer, managing editor Gary Siegel. Today we're going to discuss how the election of Donald Trump as president impacts the Federal Reserve and the economy. My guest is Scott Colbert, executive vice president, director of fixed income, and chief economist at Commerce Trust. Scott, welcome and thank you for joining us.
Scott Colbert (00:00:39):
Hi Gary. I'm happy to be here,
Gary Siegel (00:00:45):
So there will be no,
Scott Colbert (00:00:47):
Maybe when we get started here, the bank does want me to throw out a modest disclaimer to our audience that since we're talking politics, the bank likes to be a political, a politic, doesn't really like to try and take sides of course. So I may say some things here that might seem a little biased one way or the other, but we're giving our best thoughts and of course we can talk about how it's impacting our investment outlook and how we're adjusting portfolios and frankly even what we're doing with the bank portfolio.
Gary Siegel (00:01:21):
Okay. I just want to say that there will be no specific question and answer, but if you have a question, please type it in the q and a and I will ask Scott the question for you at some point during the presentation. So let's begin. Scott, what did we learn from Donald Trump's first term that could apply this time?
Scott Colbert (00:01:47):
Well, I think his direction is still primarily the same. If you think about it, when he came in the last time, he had a big focus on immigration. He had an intent to reduce taxes and eliminate some policy headaches. He also started his modest tariff campaign, particularly directed at China, and then he had a fourth leg that doesn't really seem to be much of this Trump 2.0 focused on healthcare. He was still kind of attacking the Obamacare, if you will. Of course, he was running against Hillary Clinton too when she was part of that policy. We don't hear much about healthcare in the new Trump modest things with regards to perhaps gender affirming healthcare and maybe a little bit of transgender policy, but really not too much there. He seems to have rotated, say healthcare to what he's inherited geopolitical situation that he didn't have going into his last one. That would be of course the Ukraine war that we all know about and our situation over in Gaza, not to mention other small hotspots around the world, including Yemen.
Gary Siegel (00:03:09):
So what did we learn from his first term that we could apply? You mentioned things how things are slightly the same, but some are different. Is there anything that we can tie?
Scott Colbert (00:03:25):
I think the biggest takeaway will be that while it was a rather chaotic transition and it was his first attempt to try and get anything done, I think this time we're going to hit the ground running. When I say we're going to hit the ground running, they're going to hit the ground running and they're going to be awfully forceful fairly quickly, and of course the whole tax policy situation is largely focused on just an extension of something that they've already got kind of on the books. So that's going to take a little less time too. He only started with one executive order in office last time, and that had something to do with the healthcare and Obamacare where he literally says he's going to offer a hundred of them up come Monday. I doubt that there will be a hundred, but there's going to be a lot more coming at us probably quicker. He certainly has a lot more of his appointments in place relative to where he did too. So I think the biggest difference is going to be the faster start and then the rotation from whatever would've been healthcare back in the previous administration towards geopolitical, towards a geopolitical focus.
Gary Siegel (00:04:30):
So you mentioned tax policy. One of the big changes he's talking about is he had the salt deduction cap at 10,000 and now they're talking about raising or eliminating that. Do you have any thoughts on what might happen with the SALT cap?
Scott Colbert (00:04:50):
Well, I think if you take a step back in general, I think Trump is a little more economic bent, a little more inflationary bent, a little less taxes bent, a little higher deficits bent, et cetera. I think he wants to not only extend his tax cut and job act, but he wants to throw a few other bones into the tax policy. One of the biggest, of course, was of course the elimination of most of the state and local tax deductions. We've heard floated of course, that it could go from 10 to $20,000, which still isn't a huge impact, particularly you folks that I'm talking to say up in the northeast. But he seems to be, he probably needs to have some modest accommodation here because he has a very, very narrow Congress to work with to extend his job cut and our job or his tax cut and job act. So he's going to have to sweeten the pot, if you will. The problem with that, while I always as an economist, enjoy less taxes rather than more, is it probably also increases the growth of our federal deficit or certainly accelerates it relative to what perhaps the Biden slash New Harris administration might've done. And of course, to the extent that the market wants to worry more about deficits than not, this could also mean then higher interest rates, which becomes of course countercyclical to his growth policy in the first place.
Gary Siegel (00:06:25):
And what will this mean for inflation?
Scott Colbert (00:06:29):
That's got the market spooked a bit. I think the huge backup that we've seen in the 10 year treasury since the Fed started cutting interest rates. You've seen the 10 year treasury basically back up about 90 basis points or if we go back almost exactly a year from today, say the beginning of last year, your two year treasury hasn't changed a bit four point a quarter, but the 10 year went from about 3.9% to today's 4.7%. So a backup of 80 basis points and the cash rates of course are about a hundred basis points lower. The backup in rates is a combination of what the investment market demanding higher real yields. We can see that in the tips market because the tips real yield afforded today is about 50 basis points higher than it was prior to the election and probably some potential inflationary because of the tariffs that are likely that I don't think they're not kidding at all.
(00:07:25):
I think you're going to see on day one some executive orders that you're going to see that are focused on the tariffs and those of course should be likely inflationary at least for a period of time until they're absorbed, until the market absorbs them. And then after that they shouldn't be terribly inflationary, but at least it's a one-time hit to inflation. So one change to our forecast would've been, in fact, we would've expected to see probably in inflation continuing to gradually come down under the Biden and Harris administration. We don't really expect to see much improvement, if any until later in the year. You might get off to some improvement because the comparables are fairly easy year over year, but then it gets a little tougher as the year regresses.
Gary Siegel (00:08:10):
So we've had some interesting data come in recently. Last week's jobs report was hotter than expected and inflation numbers this week were a little cooler than expected. Rates are still restrictive. Where does the Fed go? They're pausing in January,
Scott Colbert (00:08:33):
Right. No, absolutely. I mean, we've got a short term fed funds rate that's about four and three 8% right now, somewhere between their target of four and a quarter and four and a half. They've reduced it a hundred basis points once they started in mid September last year. So they brought it down, the Federal Reserve's brought it down by a hundred basis points, but when we look back over long periods of time, say from 1970 until today, the average fed funds rate has been about 90 basis points higher than trailing 12 month CPI. That's been its average. Now you mentioned the CPI statistics. We did see the CPI year over year move up from 2.7% to 2.9% while we have the core CPI decline from 3.3% to 3.2%. Now for some reason, this got the market all excited because at least it wasn't quite as much rise in the core CPI as projected.
(00:09:27):
Okay. So I think they're getting a little carried away themselves there because it wasn't that much of a change, but the market had been very pessimistic about inflation, and so any modest amount of inflation was considered a win. And we had the jobs report that of course was the semi blowout jobs report, if you want to call it that, because it was about a hundred thousand better than expectation, maybe 90,000. And then of course the revisions to Novembers were down just a little bit, but jobs averaged last year, 186 to 187,000 jobs per month. That's almost identical to the average job growth that we had from post subprime crisis to pre pandemic. That was 180,000 jobs per month. And of course the job growth last year was cooler than the previous year, which was cooler than 2022. So we've seen job growth slow with okay, a solid December print, and by the way, the seasonals for December are rather amazing as well as January.
(00:10:26):
So there can be, there's a great deal of seasonals. Plus we had the catch up still coming from the hurricane that I think took several months to work its way in because remember the October print was very low. It's not surprising to have a good November and December after such a low print. But the bottom line is this, the Fed is running a restrictive policy because right now fed funds are about 1.6% above trailing inflation. Trailing inflation is likely to cool just slightly as the year progresses, 1.6 to 1.7 to 2% over trailing inflation still is a modest break tap on the economy and the Fed does have the ability to ease should either A, the economy weakens suddenly we don't expect to see that or B inflation cools a bit quicker than the market's expecting. So the Fed has some ammo in its pocket, which is great from a forward economic perspective to keep the economic expansion moving should it need to provide that ammunition or use up some of that dry powder to help us along.
Gary Siegel (00:11:29):
Scott, what is your base case for rate cuts or hikes this year?
Scott Colbert (00:11:36):
I don't think we're going to see any rate hikes, and I think the worry about much like the Federal Reserve was willing to look through some of those inflationary jump because they thought it was transitional, and of course they were wrong about some of that. Alright. I think they're also willing to work through the tariffs and just hold tight because I think they all think they're running still a modestly restrictive policy. What I think it really does though is it puts them on hold, if you will, perma hold until they work through the initial administrative policies. They see what impact that's likely to have on the economy and then they're not going to be proactive about it, but they're going to be reactive. And I think that's a fairly smart move because I'm not so sure anyone could be proactive with regards to what's really coming at us because I don't think we really know. I think the one thing that perhaps we're underestimating though is the speed that this policy change may come at us this time relative to some of the people who think it'll be a very gradualist kind of thing that we can gradually adjust to.
Gary Siegel (00:12:41):
And how many cuts do you see this year?
Scott Colbert (00:12:44):
I do think that there's a couple cuts coming at the very end of the year now that's not what, well, the market's bounced around, right? The market's gone from basically it was four cuts prior to the election, two cuts after the election, one cut after the jobs report, and now we're back to two cuts. So the market's been bouncing around, but I really do think we will have the federal fine itself that it has the ability to basically by the end of the year, ease again, just ever so slightly to get us back to what I would call and what they would like to get to, which is what a Fed funds rate that doesn't accelerate growth and doesn't decelerate growth and doesn't accelerate inflation and it doesn't decelerate inflation. So a neutral Fed funds policy that they're quite clear about that they don't know what the neutral rate is. But I think a good place to start is what has neutral been on average over our lifetimes and neutral has been about 90 basis points over trailing inflation.
Gary Siegel (00:13:45):
So Donald Trump said he wants more stay on monetary policy, at least the ability to make suggestions. Is there a path to this and if so, what would be the impact on the Fed?
Scott Colbert (00:13:58):
Well, I don't think there's a near term path to this, although he can jawbone all he wants, and of course he has a pretty well thought of treasury secretary here that they're bringing in that probably recognizes that one of the greatest things about our country has been the independence of the Federal Reserve. He's an economic historian. He taught at Yale, so I think he'll be of a positive temperament. This is a commerce Secretary Lutnick, the CEO of Cantor Fitzgerald certainly understands the bond market and the bond market doesn't really care for the administration to interfere with a Fed that, in my opinion, over our entire lifetimes, has done a very admirable job about bringing inflation down and yet helping extend the economic cycle. He will be able to replace Powell eventually, and I'm sure that he will, but he put Powell in there in the first place.
(00:14:54):
So who's to say the next person he puts in is going to be any better anymore, any worse than what he thinks Jerome Powell has done. He also has the ability to, and this goes kind of under the radar, there will be two other Federal Reserve members whose boards expire, whose positions expire. He'll be able to replace those. And right now, of course, there's no one in charge of banking policy because the current policy chair stepped down and so he'll be able to exert some influence. But personally I'm hoping it's not a huge amount of influence. I think the Fed knows what it's doing and it knows how to operate with or without any president telling them what to do. But I think that President Trump is likely to, he has have a hard time not saying something at some point somewhere. It's really not in his character to be relatively bashful and let the Fed do its job quietly.
Gary Siegel (00:16:00):
Right. So Scott,
Scott Colbert (00:16:02):
I don't think there's going to be a tremendous influence though near term on policy, but he does have the ability, much like the Supreme Court gradually over time to replace people.
Gary Siegel (00:16:13):
Alright, so does this implied pressure make the Fed's job more difficult or they just ignore it?
Scott Colbert (00:16:21):
Well, I think they'll mostly just ignore it, but I think any pressure is pressure and any headache is headache. But Jerome Powell was fairly forceful at that initial press conference, no, I'm not quitting. No, I'm not going to be told what to do and we're going to do what we need to do. So I think the Fed will try and exert as much independence as it possibly can, but it doesn't really help the situation at all to have to also worry about the political part of this. But politics is always part of it. The Fed goes to Capitol Hill twice a year. It's entertaining television to watch the Republicans go one way, the Democrats go another at these folks. They're used to the political football,
Gary Siegel (00:17:10):
And if you watch them, you get to know which senators really understand what the Fed does and which don't.
Scott Colbert (00:17:16):
Yeah, some of it get it pretty well, and others are, I don't know where they're getting their thought processes from.
Gary Siegel (00:17:23):
So the relationship between Donald Trump and Fed Chair Jerome Powell has been rocky to say the least, but after saying that he was going to fire Powell, Trump backed down and said that he would let Powell stay. How do you see their relationship going forward? Is it going to stay rocky? Is it going to be up and down?
Scott Colbert (00:17:45):
Well, it's going to have to last for about what, a year and a half, so it's going to last. The Fed chair doesn't have to meet with the president at all, and from everything that everybody's read and written about, the president doesn't have the ability to fire the Federal Reserve chairman anyhow. So I think once Trump recognizes this, it's not really worth his time and effort to worry about it ahead of time. But if in fact he thinks that the Fed ought to be lowering rates, I think we'll hear from him that he'll say that ahead of time. And as a real estate developer, I don't think a real estate developer has ever wanted higher interest rates. So they see nothing but a subdivision and a mixed use office complex on the horizon just about anywhere they travel. So with Trump it's hotels and downtown big buildings, so I can't imagine that he will be happy with the pace of interest rate reduction because I think it's going to be slower simply because his policies are going to force the Federal reserve to delay implementation of what they had kind of had in their minds of slowly lowering short-term interest rates.
Gary Siegel (00:18:55):
Well, just like you said with real estate developers, I don't think there's been any precedent that wanted higher rates. I think it's in their best interest if they're lower.
Scott Colbert (00:19:05):
My father-in-law, ex father-in-law now passed, was a home builder, and he never met a cornfield in Ohio that didn't deserve to have a subdivision in it.
Gary Siegel (00:19:16):
There you go. So even if there is a soft landing, is there any chance that Trump changes his mind and Reappoints Powell?
Scott Colbert (00:19:28):
Well, I think there's a modest chance, and I don't think Powell really wants the job. He's had it for quite a while now, and that would be enough for most people, but there's a very, very modest chance, and of course we are still in the process of landing this economy. People talk about if we had a soft landing, we haven't even landed the economy. I mean in 2023, the economy grew at 2.9% pace. This past year it probably grew over two and a half percent when we add up all the numbers after the fourth quarter comes in, and the long-term economic growth from pre subprime crisis to pre pandemic now that includes a recession was 1.8% per year and post subprime crisis to pre pandemic about an 11 year stretch there, the longest economic expansion we've ever had was 2.1%. So we're still flying the plane faster or higher than is typical based upon our demography and productivity, and I think you're going to see it gradually cool.
(00:20:32):
Nominal growth cooled from 6% to five, it's going to be moving its way down towards a more normalized 4%, and economic growth is going to come much closer to this normal two-ish percent here eventually, and that will be the soft landing when we finally get the plane to lower its speed to a normal cruising speed. If I had to make the specific analogy, I would say, look, a Boeing 7 37 that I fly on seems to be all the time out here in the Midwest, flies at about 550 knots. The plane is still going at 625 knots and it was going at seven and 800 knots, which was way too fast. So we're still just in the process of bringing back to cruising speed, let alone a speed that is slow enough to touch down or to worry about a touchdown. We haven't come in for any type of landing at all. We're still cruising faster than typical, and we're starting out the year with a momentum that's still above that 550 knot cruising speed.
Gary Siegel (00:21:32):
So do you expect a soft landing or it's still up in the air and could change?
Scott Colbert (00:21:39):
Well, I mean anything can happen of course, but I do expect that the economy will continue to cool, but we still have the momentum from all the stimulus and ongoing deficit spending. Unfortunately, the deficit has been driven higher and higher and likely to be even grow a little faster under the new administration's policies that propels economic growth forward, held back by the higher interest rates for longer. That will probably push it back down on a countercyclical basis to something closer to cruising speed, but I don't expect a crash landing at all where really what we're doing is I think we're handing off growth from a stimulus led economic recovery post pandemic to one that's simply self-sustaining based upon job growth as is a typical economic expansion.
Gary Siegel (00:22:34):
Scott, how have market fundamentals shifted since the Fed began cutting rates and where do they go from here?
Scott Colbert (00:22:43):
Well, I think for 15 years post from 2007 until pre pandemic, let's call that 13 years, we were in this and even for the first year and a half of the pandemic just in this ultra low interest rate environment as we were coming out of an overleveraged situation, pre subprime crisis, and when you're overleveraged, you have to get under levered, and that took a long time and it took a lot of bank charge offs and capital builds and a much slower growth kind of pattern than you typically might've had. And so many people have only experienced this last 15 years if they will in the business, and they've gotten used to these rates that basically are no higher than trailing inflation over our lifetimes. When you go back to the sixties and seventies and eighties and add them in general, there's a positive real yield to be had from the bond market that real yield had gotten reduced to about zero.
(00:23:42):
I was meeting with clients the other day, their long-term bond returns over the last 10 years are about 2% now, that's actually about 50 basis points better than the Bloomberg aggregate, so it's a pretty good result, but they say, boy, that's terrible. And I said, well, 10 years ago interest rates were awfully low. Today, of course, the Bloomberg aggregate yield is closer to five than it is two, and that's the, I hate to repeat something I heard this morning, but it's very, very true from pimco, the current yield on your portfolio with about 95% certainty over the average maturity of that portfolio is going to be your return. It's very highly correlated, and with a 5% yield today over the next decade, the average intermediate bond fund is going to give you about a 5% return. So that is different policy. It's a real yield policy, and amazingly, it hasn't impacted the equity market yet.
(00:24:37):
I think we all know that equity valuations are from a standard deviation point of view, probably in that second standard deviation of richness. So we've been very, very fortunate from a financial market perspective that interest rates have backed up, afforded us real yields, but it really hasn't dented the return at all from the equity market. That is a surprise to me. I do think we have to worry a little bit about the overvalued equity markets on a going forward basis relative to a bond market that has come, if not cheap, at least very, very reasonable relative to long-term history.
Gary Siegel (00:25:14):
I'm going to put on my glasses because we're going to take some questions from the audience. I see we have a bunch. Can you extrapolate on the external revenue service and the implications of that?
Scott Colbert (00:25:28):
I mean on the internal revenue service or the external revenue? I'm not sure I know what the external revenue service is.
Gary Siegel (00:25:34):
Yeah, it says external, so
Scott Colbert (00:25:39):
Maybe they can tune that one up a little bit. So I wouldn't want to, but if you're talking about revenues in general, revenues in general, the biggest headache that we have, the biggest Achilles heel of our country is that we have this growing deficit situation, and it's fairly straightforward. The government spends $7 trillion and only takes in five. People want to complain about is it a spending problem, is it a revenue problem? Look, we take in about 17 to 17 point a 5% of GDP in revenues, we're spending 23.5%. That's a problem, and it needs to be addressed, and when I say it needs to be addressed, nobody really, really wants to address it because nobody wants to either raise your taxes or lower the money that's coming your direction no matter who you are.
Gary Siegel (00:26:24):
Next question is what kind of revenue would come in if the US acquired both the Panama Canal and the Northwest Passage?
Scott Colbert (00:26:34):
I don't actually know that specific of the revenue generation, but I will tell you probably whatever it is, it would be surprisingly modest. People are focused on this jump in tariffs, say for instance, and they want to say double the amount of revenue we get in tariffs, our tariffs generate. Basically, if you look at imports, imports are about 15% of our goods and services, and of course we all know the three big importers come from Mexico, Canada, and China. They don't quite amount to a half of that, but they amount about 6% of the 15. So six fifteenths of that come from those three countries we currently collect. If you take all the goods and services that we import, about two and a half percent think of it as a sales tax, right? We're taxing it two and a half percent. That's worth 80 billion to us, even if we double the taxation on all the tariffs from what they are today going forward, that's still only an incremental additional $80 billion of likely tax revenue. We're talking about a budget deficit that is $2 trillion, 2 trillion, and so it's when you put it on a graph, those tariffs are like drying a line across that graph.
(00:27:45):
It's almost not visible on this $7 trillion of spending or the 5 trillion of revenue. I wouldn't count on the Panama Canal, the northwest passage, Greenland or the annexation of Canada to save us from a tax perspective and tax and spend perspective.
Gary Siegel (00:28:05):
I think this one's an interesting question. They're talking about perhaps eliminating the municipal tax exemption because of the cost. So the question is if the municipal tax exemption is eliminated but grandfathered, what effect do you think it will have on the remaining municipal bonds?
Scott Colbert (00:28:28):
Well, it would drive those to ridiculously tight valuations, not that they're already not relatively tight relative to where treasury rates are today. There was already a move towards tax exempt obligations because they were, I mean, the market had as a coin toss for quite a while between Trump and Biden, and I think they felt that their Harris or Biden combination was going to be a tax raise. I haven't really seen the municipal market cheapen up materially post the election with Trump, but if in fact, for some reason that the grandfathering, the old one would make those very valuable, there'd be fewer of them around. And there are some people that are so focused on not paying any tax no matter what relative to say, paying the tax, even if it's a better risk adjusted return, that they would gobble up and own those munis and hoard them basically to maturity. I doubt that any of that is about to happen. It's occasionally floated every now and then, but the benefit to state and local governments and to tax exempt institutions, this is one of these things that's just basically pretty much part of our day-to-day lives.
Gary Siegel (00:29:46):
Next question is what do you make of the infatuation with crypto by the new administration?
Scott Colbert (00:29:54):
I didn't mention that. So that's the new one where Trump was kind of anti crypto in his first administration. Lutnik is pro crypto, his council of economic advisor head is pro crypto. Trump apparently has become pro crypto. He had a hundred million dollars of donations from crypto type companies. So here's what I think about crypto. When I say crypto, it's largely just Bitcoin. While I have no idea what a Bitcoin ought to be worth, I can tell you that the world in aggregate is under invested in Bitcoin if it decides it wants to own say 1% of a portfolio in Bitcoin. Now being an old person like me, I don't get it, so I'm not a crypto kind of person, and I think that ultimately it will be a tulip bubble type mania that pops at some point and you'll see an 85% reduction in its value, but I don't know from what level, whether it's a hundred thousand dollars per Bitcoin or a million dollars per Bitcoin, eventually you're going to talk about something that the air, because it's an asset that simply depends upon more and more people buying it. I don't doubt that more and more people will buy it because everybody I know except for younger folks have no exposure or grossly almost no exposure, BlackRock's out with a 2% allocation recommendation to their institutional clients. I don't have one institutional client. I manage 28 billion of bonds for other people. I don't have one institutional client that has any exposure to crypto at all. And so all it takes is a state teacher's fund.
(00:31:35):
I hate to say it, but at the margin, you can push the price of this up considerably. There's certainly going to be procr in terms of just the regulation. There'll be a new SEC regulator who's very procr as well. There's a third person in the Trump team there. So you're going to see easier access from an ETF perspective to more and more crypto type offerings.
Gary Siegel (00:31:58):
Scott, what would folding Greenland's economy into ours mean for the country? I assume they mean our country, not Greenland.
Scott Colbert (00:32:07):
Yeah, I don't think Greenland's wants to sell, but it's really, I think mostly a strategic shot at Russia who wants to basically control, if you will, the northwest passage, so to speak, and Greenland is a strategic point for us to, I'll say interfere or at least exert a defensive presence. So from a strategic point of view, Greenland's a pretty strategic global position for our US defense forces. I'm not sure what the raw materials and the minerals and the wealth of Greenland. I think we'd all agree that buying Alaska for no money was a good deal, and I think we think the Louisiana purchase was an awfully good deal too, so I don't doubt that. I think it's just really a shot at China and Russia, mostly Russia, to recognize, look, those folks have expansion, an expansion focus China with their China Sea and the fake islands that they're building and the possible embargo and takeover eventually of Taiwan and of course Russia. With the attack against Ukraine and wanting to push the Russian boundaries out, I think it was just Trump's way of pushing back geopolitically.
Gary Siegel (00:33:34):
What do you feel the Trump two feel, the Trump 2.0 economy will have on the federal agencies and new pending regulations that financial institutions will have to comply with since there's a potential impact for the economy in certain instances,
Scott Colbert (00:33:55):
The biggest thing will be for the bigger banks, of course, with the Basel three implementation and that overall top-down leverage ratio requirement. So in general, our banks are so well capitalized and this is we buy a lot of bank and financial debt because basically the bank and financial institutions in this country are in marvelous shape. They've really never been in better shape. They have higher levels of capital than they've ever had. Their charge offs are very, very low, if not almost at the lowest points ever. The only hole that most banks have is a little bit in their balance sheet from the backup and interest rates because of their bond portfolios. But people are now getting the idea that as those bond portfolios mature and you get to reinvest back in higher securities or loans, your net interest margins are expanding. They're expanding fairly quickly now.
(00:34:46):
So as basically they catch up. And so a higher interest rate in general and a positively slope yield curve is good for the banking industry. But regards to the regulation, I think you are going to see a material easing of course in any merger and acquisition as well as a reduction in any need for additional capital requirements based upon Basel three, probably no extension at all of the shock treatments that they put the major banks through to smaller and smaller banks. So I think it's very pro banking. It's also probably positive from a merger and acquisition standpoint getting things done, and it's very positive if you're some of the bigger banks subject to all the stress testing and possible Basel three regulation,
Gary Siegel (00:35:35):
What is the impact to rates when the government continues to add to the deficit?
Scott Colbert (00:35:41):
It's not good, and I think the market's finally picking up on that. That's the backup basically in the real yield because of course, with 28 billion of public debt outstanding and 33 trillion of total, total debt outstanding and likely to grow by what if the budget deficit is going to be 7% of GDP. GDP is, let's see, about a or a $30 trillion economy. So 7% of $30 trillion is an additional $2 trillion of debt just to finance the federal government spending this coming year. So it's a growing pile of assets that basically have to be priced at a higher yield to clear the market, and the market is finally, finally, finally paying attention to this. You'll recall that Clinton once woke up and said, what do you mean my economy and my administration is in the hands of the 30 year Merrill Lynch long bond trader or the Solomon Long bond trader?
(00:36:38):
I won't say that the bond vigilantes are back and forth because of course a 5% interest rate environment, it's still a somewhat below average interest rate environment from what we're used to, but still, there clearly is some recognition now in the bond market. These deficits are substantial. They're going to have to be rolled over. They're going to continue to grow unless Elon Musk is a miracle worker with his Doge committee, which I doubt that they will be. So it's a recognition that it's big and it's bad. Unfortunately, this deficit will continue to weigh on us. When does it break us? People have asked me this forever and I said I would've thought it would've broke us years ago, but it just turns out that the world is willing to finance the United States because we truly are the only superpower. The dollar, honest to God is the reserve currency, and we have the highest yields of basically the safest place to put money in the world. So we attract the financing. 70% of our deficit is financed internally. 30% is financed through, I'll say the munificence of foreign folks who are willing to put their German marks or euros or whatever into the United States economy.
Gary Siegel (00:37:57):
I'm going to combine the next two questions. Do you think Trump will be able to eliminate the CFP be and what might the new administration's bank friendly policy mean to the fate of the CFPB?
Scott Colbert (00:38:12):
Well, if you don't like Elizabeth Warren, then Trump was your guy, right? So those two folks don't care much for each other. I don't think you're going to see the elimination of the CFPB, but you may see them start to focus more on perhaps rather than the average bank, which doesn't wake up and want to do harm to anybody compared to say these payday lenders and things like that, that are just egregiously using your usury type rates via fees. So I think you'll see a rotation towards probably the marginal financial participant in the FinTech space at the, I won't call it the expense, but to the benefit of the average investment grade bank who wakes up every day and basically tries to do exactly what it's supposed to do, be an honest bank out there with honest lending standards and just helping the region make forward progress. So I think you'll see a rotation, but you're certainly not going to see an elimination from the CFPB and frankly, I think it's a rotation long overdue.
Gary Siegel (00:39:20):
Scott, are there any estimates for the increased cost of construction in the US due the proposed tariffs? Any thoughts on the impact to borrowing for the new projects with higher costs and interest rates that are still higher than they were a few years ago?
Scott Colbert (00:39:37):
Bank lending in aggregate is slowing and it's slowing because we have a higher interest rate environment. Projects that used to pencil out, let's say apartment complexes don't pencil out like they used to. Well, we do business basically from Denver to Nashville, from Minneapolis to Houston, and some of the biggest developers out there have had to grossly scale back their expectations for development because of the higher interest rates specifically, I don't think we know exactly what it is they're going to tariff, but whatever it is is likely to raise the cost of certain materials for the building industry. And of course, these higher interest rates just in aggregate are probably materially hurtful on a relative basis compared to say a modest uptick in the cost of whatever supplies you're going to need. Electrical componentry, perhaps chips, bricks from Mexico that are already prefabricated lumber from Canada.
(00:40:39):
Who knows what the tariffs might be that add to your cost, but I don't think it's certainly not positive and the higher interest rates aren't positive. We're in an economic cycle. We're always in an economic cycle. I jokingly like to often say it's like a Tom Cruise movie that is basically the same. Tom's really good at something to begin with, something bad happens to Tom, someone needs to shake him out of it, and by the end of it, he's back to race car driving or bartending or lately flying a jet plane. Our economy's the same way. The Federal Reserve pushes back against inflation by raising interest rates that beats up the cyclical part of our economy and certainly the building industry is the cyclical part. Steel, aluminum, bricks, housing cyclical part of our economy autos, the higher interest rates, slow it down, it helps bring down inflation and basically then when they start to lower rates and interest rates come back down is when the cyclical part can get restarted again. So we're in that cyclical part, the beginning parts of the economic cycle that the Federal Reserve has done on purpose in an attempt to slow things down on purpose to bring inflation under control.
Gary Siegel (00:41:53):
So a similar question. I just lost it. Okay. Are you concerned with the increasing volume of non-bank lending?
Scott Colbert (00:42:08):
I think we should all be a bit concerned about it, but it's not a subprime crisis type situation. These non-bank lenders are effectively equity-like folks, investors that they're putting risk-based capital into them for equity-like returns. And what I mean by this is, listen, the subprime crime crisis was very damaging. It was a levered situation. You had banks long subprime loans that they had borrowed money from depositors or whoever to own these loans, and when they started to disappear, there was only about 10% capital to support them, so it didn't take many losses before you had a capital situation and a leveraged situation. Most of these funds aren't built upon lending. These are equity investors that are putting, rather than saying, putting their money in the stock market, they're using it as an alternative investment space. And so they're pension funds and insurance companies, they're long only investors in general, when the NASDAQ bubble popped 50% down drastic reduction in stock prices, our economy was barely ded because those were equity-like situations with equity-like problems.
(00:43:20):
I think when these marginal credits blow up, it's going to be much less problematic to the country as a whole because the losses will be absorbed by those that were taking equity like risk and not borrowing the money to put the money in. If you're out there borrowing money to buy a high yield bond fund or borrowing the money to buy a private credit fund, I think you'll be, you're going to be doing a lot. I don't think there's a lot of that at all. And then that's a dangerous move compared to just reallocating your stock bond portfolio. Taking some of that equity risk and putting it in alternative securities that encompass private equity and private credit,
Gary Siegel (00:44:06):
Will the instability that Trump brings to office make us banks less attractive? Will that force rates up?
Scott Colbert (00:44:14):
Well, I think that by instability, I think it's uncertainty. There's always uncertainty. There's a little less uncertainty in the sense that we know what the administration is. There's a great deal of uncertainty, I'll call it policy fog. We have yet to accept the policy fog. The markets aren't taking it poorly yet, and you've seen the healthy earnings from the major banks just recently pop up those stock prices, but I think just its policy fog in general slows business activity, not so much the banks and their willingness to lend banks have a tremendous balance sheet leverage to provide loans into this economy to the extent that they pencil out. Will there be some banks that are somewhat hesitant to lend maybe into spaces that are somewhat politically active, let's say green energy, for example, clean energy projects? Sure. Do you want a loan into that space right at the moment when policy's likely changing materially?
(00:45:15):
Probably not. But in general, the banks are in such a healthy position and looking and actively seeking loans and loan growth has calmed. It's on an aggregate basis year over year. It's barely growing at all when you look at the Federal Reserve statistics. So I think there's still a great deal of lending to do, and I'll just call it policy fog that we have to work with. I don't think it's going to damage the banks at all specifically. It does slow the economy down a little bit until we know what these policies are and how they're likely to impact your business. You're certainly going to be a little bit cautious if you think any of these policy changes are going to materially impact your business at Commerce Bank. To the extent that regulation has reduced a bit, we don't think that's particularly a negative and frankly, higher interest rates for longer help most banks' balance sheets.
Gary Siegel (00:46:08):
We're short on time. Can you stay or do you have to go? We have some more questions from the audience.
Scott Colbert (00:46:14):
Oh, I'm fine. I'm fine here. I'm here. Yeah.
Gary Siegel (00:46:17):
All right. What impact do you feel Trump will have on home buying home building should buyers look for longer fixed term rates or consider shorter adjustable rates?
Scott Colbert (00:46:28):
The worst part about the home situation in our country is that a, there's not enough product to go around, and that's largely because during the subprime crisis, we went from an oversupply to a fairly perpetual undersupply. And secondly, affordability is at an all time low with affordability being driven by what three factors? The higher mortgage rates, the higher home prices, basically because of higher cost to build a new house as well as a limited inventory, and then relative to your incomes where our incomes have grown but not nearly as quickly as home prices have appreciated and those mortgage rates have gone up. I would encourage anybody to, basically it is the American way to save money. Yes, homes are expensive. There's only been one time in our life where in general home prices declined and that took a subprime crisis. Home owners today are in great situations.
(00:47:23):
They have huge equity buildup. There aren't any big delinquencies going on, and so I don't think you're likely to see huge decline in home prices. That was a one time only kind of event. Everyone kind of hopes for that, again, if they're buying a house, but in the long run, home prices tend to appreciate it about the CPI plus 1% over the long run. So I'd encourage everyone to get into it. You might as well take a fixed rate mortgage and if you can absorb it and live with it and hope and pray, and I do think you'll see some modest reduction in interest rates over time that brings those mortgage rates down back below 6%. But anybody that's thinking that there's a three or 4% mortgage on the horizon, there is not unless we have another financial crisis or economic crisis that sends interest rates to below inflationary rates.
(00:48:11):
That was really a 13 year opportunity to take a bite at a very low interest rate. Apple that I don't think many of us are going to see. Again, when I was a kid, my parents had a 6% mortgage. I thought I would never see a 6% mortgage my whole life. And then of course, I was offered 13 years of a below 6% mortgage rate environment, and of course, many of us took advantage of that two and 3% rate environment that we had for those couple years and refinanced into it that will hold supply down because nobody wants to give up their home with their 3% mortgage, but eventually time will heal that even, and you'll start to see supply move into the market from an existing home perspective. But no, get that home, get it as fast as you can, have your parents help you out, figure out how to get that down payment and get in the home owner track. It's not the opportune time, but I don't know that there really is ever rarely a great time short of kind of what we just went through post pandemic where frankly homes were not rising in price and interest rates were collapsing. That was one small period of time there where homes were exceptionally cheap. And then of course, post the subprime crisis from 2008 to 2012 forms were awfully cheap as well.
Gary Siegel (00:49:25):
What is the feasibility of Fannie Mae and Freddie Mac becoming private?
Scott Colbert (00:49:29):
Yeah, I should have addressed that when somebody asked about the agencies. I focus solely on the banks. This has been going on of course, since 2007 where we've had Fannie and Freddie in this limbo of receivership that nobody knows really what it means. I think Trump would like to put this aside and get it back to being a private entity that basically has a AAA credit rating that can guarantee mortgages rather than having this implied government rating. I do think it helps the market. It helps the mortgage market tremendously to have a government guarantor of mortgages. So I think that's the positive part about not changing a thing because everyone views Fannie and Freddie as a def facto government guarantee on a mortgage, but I think the market could also live with a hugely capitalized AAA rated Fannie and Freddie as basically their wrapper on pools of mortgages as well.
(00:50:29):
I think the biggest interesting thing is that the preferred stocks that maybe some of your banks still have clung onto have pretty much doubled in price post the Trump election. If a preferred stock was trading at $25, preferred stock was trading at $5, it's up to seven or eight or nine, and some of those $50 preferred stocks are up to 10 bucks a stock. So if you still have a residual Fannie and Freddie's security that isn't paying any interest, there is some modest hope that eventually it would either turn the interest back on, or B, even the home run would be some repayment of some of that interest that I don't think none of these were cumulative. So I don't think there's any recoup of any interest that was ever disappeared, but it's a home run win if all of a sudden you've got a bond that's paying no interest and all of a sudden a preferred stock whose interest turns back on, it's a speculative trade. I personally haven't made it. I haven't even done it with any personal monies. People have been disappointed over and over again waiting for this to happen.
Gary Siegel (00:51:29):
President-elect Trump mentioned earlier this week that he would create an external revenue service division to collect tariffs from importers, including new tariff amounts and reduce burden on taxpayers consumers and offset potential tax cuts. How would modifying tax tariff collections process impact supply chain import export levels and relationships and from their consumer pricing?
Scott Colbert (00:52:00):
Yeah, so here we've done a lot of work on this, and again, I'll go back to the currently with 15% of our goods and services imported about 12% exported. We typically run about a 3% trade deficit. It's average 3.2% for the last 10 years. So that's the trade deficit here about our import. We import more than we export. Okay, so we're currently earning $80 billion on all those imports. Can we tax them all? Absolutely. Can we tax them selectively? Hopefully, it's the expectation that the folks surrounding Trump are interested in doing this from a strategic point of view to basically from an economically independent point of view to recognize that, look, we shouldn't depend upon all of our antibiotics come from China. We shouldn't depend upon cheap things solely from China. And of course, from a fair trade perspective, they're looking at taxing Mexico. I think Canada is awfully fair with us.
(00:52:58):
We're awfully fair with them. I'm not sure what the big take on Canada is, but we do import some oil and of course timber and a lot of autos, parts and autos from Canada. But beside all that, how much really can you get on tariffs if in fact you did 25% across the board? What does that mean? Well, 25% across the board on 15% of our goods and services is fairly substantial. 15% of our economy is what? It's four and a half trillion dollars. So if you tax that by 25%, well that's a tremendous amount of money. That's a trillion dollars. But recognize we're only getting 80 billion today at a two and a half percent tariff rate in aggregate. The highest tariffs have ever been in this country was in 1933. It was 19.8%, and of course, many people suggested that was widely one of the compounding effects of our long great depression.
(00:53:56):
Even if Trump approaches half of what he's talking about right now, it probably impacts the CPI by as much as one to 1.2%. I think he gets about half of half, and it takes a while to get there. We have in our projections an additional 6% increase in the CPI six tenths of a percent increase in the CPI that wouldn't have been there if the Harris Biden administration had been there. So we expect the near term impact over the course of a year to raise the CPI by six tenths that basically totally offsets the decline that was coming. And so this is why basically the Federal Reserve is on hold and they want to see what the impact of these tariffs are. Finally, I'll mention this, just because you tax something doesn't mean you're going to earn any money on it. If you tax it at a hundred percent like we do Chinese EVs, you get no EVs and no tax revenue.
(00:54:53):
So we will, and maybe the easiest thing to think about is this. When Trump taxed put tariffs on Chinese furniture, Chinese furniture, almost all imports for furniture, were coming from China. Now it's only about half of imports. The other half come from Vietnam, and basically you've had a reduction by half of Chinese imports. The same thing will happen with the tariffs. If you tariff something from Mexico, somebody else will say, well, where can I put it? Can I put that part in Indonesia? Can I put it in Malaysia? Can I put it in Vietnam? Can I put it in South Korea? Can I put it somewhere where it's not being tariffed? Or as an American will say, maybe I don't want to buy that. There's a reason that Tim Cook is going to be on the stand with Donald Trump, and not to mention Zuckerberg and Elon Musk and a host of other tech bros, if you will, they don't want tariffs on their iPhone, and the average person doesn't want a tariff on their iPhone.
(00:55:49):
I'm talking to you on an iPhone. I don't want to pay 10% or 20% more for my iPhone. So they're going to be selective about it, and I don't think it's going to be as broad based, but it's going to be targeted, mostly targeted to China. And even when you tariff something, that doesn't mean you're going to get the revenue because oftentimes, of course, simply we'll buy less of it. I don't think it's going to be as big an impact as people think. And then, like I said, we're a $2 trillion deficit. Even if they double the amount of tariffs that we're getting, that's only an additional 80 billion, even if they double it and double it, that's 160 billion of a $2 trillion deficit.
Gary Siegel (00:56:27):
What do you think is the likelihood of the incoming administration pursuing re-review of modifications to recent actions by CFPB, such as overdraft fee cap and restrictions, lawsuit versus Capital One, credit card, late fees, et cetera?
Scott Colbert (00:56:46):
I'd just really be guessing there. I mean, I'm not tuned into it to such a fine point that they would, of course, as a banker, I'm all for more flexibility rather than less. Whether they're going to retroactively address some of these situations or rather be more proactive in terms of just fewer regulations going forward is hard to say. Trump, he has of course, not only a Wall Street backing, but a populace backing from a consumer's point of view, they like the fact that maybe the overdraft fees are capped at $7. And so let's not forget that it was a large right wing populous group of people that largely drove Trump to the polls. And it's not necessarily the tech folks and the banking folks and the Wall Street folks. He has to balance both sides of this equation, which is tough to do, and it's rather amazing that his treasury secretary seems to have done this and threaded that needle pretty well.
Gary Siegel (00:57:48):
Does the Trump administration's perceived erratic, foreign and domestic policies put the US dollar at risk of being demoted as the world's reserve currency?
Scott Colbert (00:58:00):
Yeah, I don't think so in any way, shape or form. The reason that we're the world's reserve currency and used in almost all transactions is because we are superpower America now to the extent that the Trump administration risks us not being superpower America, not only the largest GDP by far, but it would take China, Japan, Germany, and let's see who's the fourth largest economy in the world. If you put 'em all together, you still don't get to the United States economy. That's why we're the reserve currency. But the reserve currency has changed over our whole lives. It was the Dutch gilder once Italian for a while, and then of course it was the British pound for many, many years, but we're here for a reason and it took two world wars and the rebuilding to put us in this situation. But it's not likely to be lost lightly under anybody's administration. Even if you're anti-Trump and don't like the uncertainty and everything that he's possibly going to deliver, I doubt that it's going to hurt us from a reserve currency point of view.
Gary Siegel (00:59:18):
Okay. I'm going to make this last question. How might our current economic cycle impact the commercial real estate market, and do you think the commercial real estate market is a big issue?
Scott Colbert (00:59:32):
It certainly was the key biggest issue to start the economic cycle, and we still have many cities. I'm in St. Louis, the bank's headquartered in Missouri, and there's still a lot of office property in downtown Midwestern cities that's sitting there relatively empty. We still know what's out in San Francisco. And when you look at the commercial mortgage backed securities market, when you look at it specifically, while it's functioning very, very well within the commercial mortgage backed securities market, you can see many office properties are not getting refinanced. They're getting rolled over in those conduits at basically a below average interest rate level and kind of extending and pretending. So while we're still probably in the third or fourth inning of the commercial real estate market From office property perspective, it's important to remember the commercial real estate market is not just downtown office property in St.
(01:00:27):
Louis, Detroit or San Francisco. It's warehouses and strip malls and all kinds of other things. And so an aggregate perspective, I think this is yesterday's news now in general, even many of these office properties seem to be approaching kind of a bottom trade level, which is about 25 to 30 cents on the dollar of where they were appraised at, say, 10 years ago or five years ago when the loans were made. So those charge-offs still have yet to be incurred. The losses have to be absorbed. We're working our way through it slowly, but I don't think that downtown commercial office real estate is enough to sink the commercial real estate market in aggregate. And most banks have worked well through this, with the exception of a couple that just have huge concentrations in CRA or very, very niche books of commercial real estate business that are still under the gun, say for example, income subsidized housing in New York City or something like that.
Gary Siegel (01:01:33):
Well, this concludes our event. I apologize to those who submitted questions that we didn't get to. I'd like to thank our audience for tuning in, and a big thanks to my guest, Scott Colbert, executive vice President, director of Fixed Income, and Chief Economist at Commerce Trust. Have a good afternoon all.
Scott Colbert (01:01:52):
Thanks, Gary. Nice to talk to you.
