Top of the Morning: CIO Strategy Snapshot - Fit check
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Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. President Trump has officially taken office and already signed a flurry of executive orders. In addition to that, there was important economic data last week on the U.S. economy suggesting that it is in a good place as Trump 2.0 begins.

So joining us today for the CIO Strategy Snapshot to discuss this all, glad to welcome back Head of Asset Allocation for the Americas with the UBS Chief Investment Office, Jason Draho. Jason, thank you for joining us on this Tuesday morning. As we talked about last week, a lot has happened over the past few days, so plenty to catch up on. Thank you for joining us today. Good morning, Dan. Yes, it's a monumental moment in terms of American politics.

and economics. So a lot to discuss this morning. So where to begin, Jason? Perhaps we can start by addressing the state of the economy. This is President Trump Takes Office. Now, in your latest blog, title is Fit Check, you describe the economy as dressed to impress. So what exactly do you mean by that? Well, first, maybe I should clarify what I mean by Fit Check. For those of you who see TikToks or maybe on other social media platforms, Fit Check is...

a form of a video where someone, usually a woman kind of like, you know, shows off her out what she's wearing and could ask him for a fit check, like, you know, feedback from people. Um,

So given there is a TikTok ban that's been pulled off for a little bit of a while, I kind of thought, well, it's appropriate to do a fit check for the U.S. economy as Trump takes office. And the address to impress is one of the captions that often people will use, these kind of content creators describe their outlook. And I think that's an appropriate way to think about the U.S. economy right now. If we look at the data we have, and the data we have is most of the relevant stuff for December. And what

And whether we look at growth or inflation, it's all pretty positive story. So just on growth, the data that has come out, whether it's for the labor market, these ISA manufacturing and services indices, industrial production, retail sales, and particularly kind of core retail sales that's not subject to price fluctuations and gas prices and food prices, all those data kind of exceeded expectations for December.

The Atlanta Fed has a GDP tracking estimate for the fourth quarter. It is now up to 3%. It had dipped down 2.5% at the end of December. For context, the economy grew at 3% in the third quarter. If it grows at 3% in the fourth quarter, we're looking at a full-year economy growing at about almost 2.8%. And not only a sign of slowdown. It's not as if it was strong QI that it gradually declined. It's kind of holding steady.

So the economy is in good shape, the momentum is strong, that should continue. There's not a lot of reasons to think that's gonna suddenly change and you know, bar it against some sort of shock, but we'll get into that. The bigger economic news last week was the inflation data, you know, the CPI data and also the PPI data. They came in a little bit better than expected, at least on a month over month basis. The year over numbers are being impacted by kind of some base effects, but month over month, it was a good number below expectations.

A key part of the inflation data is the shelter part. It's over a third of CPI data, a little less than that for the PC data the Fed focuses on. And what we saw is another month where the step down that we saw in December for owners or November for owners of private rent, that was also relatively contained. So to give you some perspective, on a month-on-one basis for a year ago, two years ago, that piece of inflation was running at 0.6, 0.7%.

It's going to get trending lower, but in November, it was down to about 0.23. For December, it was 0.31. This is important because if you have a third of inflation indexes clearly still disinflating,

And if we actually took out the shelter piece from CPI inflation, it'd be around 2%. We'd already be at the target. If this is trending lower than it should be, then that's a sign that the inflation should gradually get back towards 2%. So the inflation reacceleration or sticky concerns, they're still a risk. But the data this last week doesn't suggest that that is a significant risk or a baseline view. So once you have that economy that's growing strong, that still seems on a track towards gradual disinflation,

And that's a pretty good kind of state for President Trump to be – of the economy to be inheriting on for his new administration. So again, that's why I kind of classify it as just or impressed because by any measure, the economy is pretty impressive.

Now, Jason, before we get into the new administration, just based on this economic outlook you've just shared with us, what are the implications for the Fed cutting rates this year? Well, the inflation data was important because that's where the markets have become concerned that while the growth is holding up, inflation is, or disinflation is basically falling out. Is there a risk that it gets sticky at the high 2.8% range, around 3%? Could it even reaccelerate?

So the CPI data that was, again, below expectations and showed that the disinflation still seems to be kind of on track. That's important. And what we saw is the market pricing for the Fed rate cut that had fallen down to about almost only one cut this year and not wouldn't be done until December. The market is back to pricing now around 1.6 cuts this year with one cut basically priced in for the end of June.

Our view from last December after the last FOMC meeting was that the Fed would cut twice this year in June and September. So now kind of aligned with what the Fed is projecting based on the top plots, pretty consistent with market pricing.

The caveat is that we would need to see, and the Fed would likely need to see, the labor market continue to kind of cool just a little bit, certainly not reaccelerate, and inflation progress to continue in order to feel comfortable to gain cut rates, you know, at length of this year. That's likely to happen, but now the Fed is in a good position, a sort of defendable position to say, you know, we've cut rates a decent amount, the economy's holding up, inflation is still coming down. Let's pause for an extended period, for multiple months, to assess inflation

you know, the data to make sure inflation actually is following, but also have time to assess the policy announcements and actual policy of the Trump administration to see what impact it could have on growth, inflation, and does that alter what the Fed needs to be doing?

So relative to where we were in December when the Fed cut 25 basis points, it was a hawkish cut. Our view hasn't fundamentally changed. The data has evolved in a way that it's consistent with getting the two cuts. And the market price is now somewhat aligned to it. So again, adding it to the growth data, the inflation data now, what the Fed is –

Instead, it's going to do what the market expects it's going to do. It's all kind of aligning in a pretty good story at this point in time. So now turning to President Trump, as we're recording today, Tuesday morning, he hasn't been in office for even 24 hours, yet there's already notable policy implications. How would you sum up, Jason, the policies thus far? And what could it all mean or signal about future policy out of the White House?

Well, clear that, you know, from an economic perspective, there's four main channels of policy. One is fiscal, you know, or tax cuts. Second is deregulation. Third is tariffs. Fourth is immigration deportations.

There was very little on the first day in terms of fiscal policy. There's things that the administration and Congress has to do, including having another deal to fund the government for the rest of the year. That expires on March 14th. The deal with the debt at some point in time, good

Good chance that what they end up doing is having probably two different bills, even though there may be some incentives to have one reconciliation bill, but a bill short-term to fund some immigration and defense funding, and then a bigger bill later this year, probably by the summer, that's going to deal with the tax cuts that expire at the beginning of next year. But nothing really new that kind of came out from the first day in office.

On deregulation, Trump did sign an executive order saying that no new regulations until the government is fully in place and the administration is fully in place. He's also done some things such as take away federal government workers' employment protections, mandating they would be in office five days a week.

Some thought is that that's to help to kind of shrink the workforce overall. You're also making it easier to fire some civil servants. So that under the deregulation account, that sort of, you know, some action taken there. A number of executive orders on immigration, things that were kind of expected, you know, such as declaring a national emergency at the southern border. The real question is the deportation of immigrants. It's going to start with kind of criminals. You know, how many people, how soon they can round them up, that's kind of an open question.

Presumably, some of these people who they're going to target first are not in the labor force or at least not conventionally. So the economic impact for 2025 from immigration and deportation should be relatively minimal. The real sort of story from yesterday in terms of the policy that was what was announced or what maybe wasn't announced on tariffs, there was a fear in the marketplace that on day one, there could be announcements of new tariffs that take effect immediately.

Instead, what we got even before the inauguration were media reports that there'll be a memorandum of understanding that dictates that different economic agencies and departments investigate trade practices of other countries, how they might be harming the U.S., and sort of report back, and that would guide subsequent investigations.

you know, trade policies, tariff policies going forward. It doesn't mean, you know, tariffs won't be used, but it wasn't sort of the worst case scenario that kind of out of the gate they would be implemented.

I would caveat that that was in the morning. By the evening, Trump, in an informal press conference or answering reporter questions in the Oval Office, did say that – and asked about tariffs on China or Canada and Mexico, that he's prepared to impose a 25 percent tariff as soon as February 1, which is, of course, only 10 days away.

What materializes, to be seen, he has said these things before. Back in his first administration, he talked about 25% tariff. On Mexico, because of lack of action on the border, he did not follow through. So it's still unlikely that that falls through this quickly, but it's clear that he's using these deadlines to force action by both countries. But on net...

I think the read-through is that, you know, at least one day, the worst-case fears of tariffs did not materialize. Some of the rhetoric on China has been a little bit less than, you know, expected, maybe going back a few months ago.

I mentioned the TikTok, the fit check kind of videos. President Trump sort of announced that there'll be 75 days to give more time for ByteDance to sell TikTok to U.S. buyer. So by sometime we'll see whether if they don't, will he actually enforce the ban or not. But clearly there's some leeway that he seems to be providing. And you can sort of draw conclusions from that, which might be a little bit dangerous. But the read through from yesterday is that

Our view that ultimately it'd be more selective tariffs, universal tariffs, but perhaps only on the most sensitive goods. That might be a reasonable base case. The broad base tariffs that were being sort of feared as a downside case, nothing that happened yesterday would sort of suggest that's more likely if anything that suggests to perhaps a little bit less likely, you know, all sequel, but

These things will be very fluid. It could certainly change within days, weeks ahead. Well, Jason, that was a very helpful recap. And I'm sure, as you pointed out, we will learn a lot more in the days and weeks ahead. So as we begin to close out today, Jason, what does this all mean for CIO's investment outlook? And what should investors be doing right now? Well, we think kind of big picture, medium term for the full year.

The economic conditions I described of good growth, inflation coming down, the Fed to be able to cut rates, that's a favorable backdrop for risk assets for equities to continue to perform well. That's why we maintain our 6,600 price targets for the S&P 500 by year end.

Yeah, the path to get there can certainly be choppy. And if all you have to do is look at the performance of the S&P for the past month, it looks like a little bit of like a sawtooth up and down as economic data comes in, as policy announcements are made, or at least actions are potentially announced. I think that will be the case until we get real clarity of what the Trump administration will do, plus specifically on tariffs. I think the other policies generally are neutral to positive for growth. It really is the tariffs that have proposed a significant downside risk.

And so until there's clarity on that, markets are likely to be choppy. Same thing, the most recent data is good, but we can easily have data that comes out in February for January that is above expectations with growth again, this strong labor market and job growth is strong, inflation is surprised to the upside, and suddenly we go from

supportive data to data that perhaps suggests the economy is running too hot, the Fed may not be able to cut, rates go higher, and we're kind of back to where we were. So that is sort of the path we're on for the time being until there's sort of clarity on the inflation trajectory and the tariff policy trajectory. But longer term, ultimately those things should play out in a way that is ultimately supportive for risk assets. Yeah.

Within equities, our favorite area right now is the US just given the overall view is that the US economy is clearly doing well and some of the policies such as cash would be worse for other countries than it would be for the US. We like tech sector. The tech sector is the most attractive sector. It's actually underperformed a little bit year to date on some restrictions and they were imposed by the Biden administration on semiconductors. Also, perhaps a little bit of profit taking. We've seen a rotation for the first couple of weeks.

more towards value cyclical thoughts. But ultimately the fundamental story for AI, the investment, at least all the commentary coming out suggests that team is well in place and we expect that will perform quite well this year.

Financials is another sector that we like, and if you look at the earnings for Q4 for the biggest banks last week, they were all quite strong, better than expected, and the financials led the markets higher last week. And we think this environment where good economy, more pickup in corporate activity, like M&A activity, deals, making activity that's good for banks, and ultimately for the disc, you know, bias towards cutting rates, all that should be positive. Same thing with a regulatory environment that should be more favorable for financials.

Within fixed income, we favor kind of high quality fixed income. These low level of yields don't need to take a lot of spread or credit risk to get income. Yields have been very volatile. They moved up a lot. They're already down 10, 20 basis points if you look at the 10-year just in the past couple of weeks based on that inflation data.

But there's a lot of volatility, rates that again easily back up depending on what policy announcements are made. So rather than extending duration too much, we like kind of the five to seven year point of the curve to add a little bit of exposure to interest rate risk, but not being too exposed to rates going higher if things kind of end up heating up, which is still very much a risk. Or fiscal policy is intended in a way that would be inflationary or larger deficits. Again, the markets will react to it negatively too much.

And the final thing is just to remind people that one of our messages is kind of go for gold. We think gold has seen a good upside and there is a risk-off hedge instead of inflation hedge, but there is also a secular story that makes gold attractive as central banks continue to buy gold to diversify their reserve holdings and recent data of just the past week suggests that.

Again, central banks are buying a significant amount of gold. So it's a bit of a hedge against an environment that by and large is relatively favorable for risk assets. Gold is something that looks relatively attractive to add to the portfolio right now. Well, Jason, very productive conversation. Thank you for joining us to keep us current on CIO's Investment Outlook guidance when it comes to

positioning and recapping for us what has been a very busy last 24 hours in Washington, D.C. Thank you again, Jason. Do look forward to picking back up with our conversation in the week ahead. You're welcome. Have a great week. Again, today we have been joined by Jason Draho, Head of Asset Allocation for the Americas with the UBS Chief Investment Office. I will point out that Jason's latest blog, which he has been making reference to today, title is FitCheck,

is now available for you on ubs.com forward slash CIO. From UBS Studios, I'm Dan Cassidy. Thank you for joining us.

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