Trump's New Cabinet and the Economy

We recently sat down with Dominic Nolan, CEO of Aristotle Pacific Capital, to get his insights into the potential economic impacts of the new Trump administration, the state of the markets and economy, Fed expectations and opportunities in fixed income. We finished with a random round of questions and personal reflection.

Market Performance: Total Return

U.S. stocks and bonds ended the month higher, but it felt like a wild ride. What happened?

We had a new presidential administration come in, and they have a different agenda than President Biden’s administration, including a willingness to impose higher tariffs and a larger crackdown on illegal immigration. The markets are essentially adjusting to change. The S&P 500 Index was up 2.78% in January and 6.22% over the past three months, a time period that started just before the election in early November. That’s strong performance. Over that same three-month timeframe, the Russell 1000 Growth Index was up 9.55%, which shows the tech sector continues to roll. But in January, the Russell 1000 Growth was slightly lagging the Russell 2000 Value Index. What we saw in January was a broader rally in equities, which is healthier for the economy.

What about bonds?

Rates have been fluctuating, but due to rate levels on investment grade, you’re clipping about 40 basis points a month. Last month, bond markets were up 0.53%. Meanwhile, leverage finance—where you’re clipping a much higher coupon—was up about 1% and 2% over the past three months. Risk is still winning.

Magnificent 7: Concentrated Performance

What about the Magnificent 7 so far this year?

It’s a mixed bag. Five of the seven names were down in January, but the real story was Nvidia. On Jan. 27, it fell by 24% on the DeepSeek news out of China. What’s fascinating is they clawed back most of the losses by month’s end. What I find encouraging is the S&P 493 outperformed the Mag 7 (3.54% to 2.32%), which shows market performance was much less concentrated than last year—but it’s been a small sample size of just one month.

10-Year Treasury Yields Remain Range Bound

Was the volatility in the markets as bad as it seemed in January?

I did some checking on the VIX Index, also known as the Fear Index. Though it felt like January was highly volatile, the VIX measure of volatility was in the teens. To give you some context, a level greater than 30 indicates heightened volatility and below 20 typically signals stability. The VIX has not hit 40 since October 2020, which means we have gone through a period of four-plus years where the volatility has been relatively subdued. This may explain why January felt a lot more volatile than the numbers would indicate.

U.S. Treasury yields were largely unchanged last month, except for a bit of steepening at the back end of the curve. Anything new to report?

In general, we saw a small climb in rates in anticipation of inflationary policies the market is expecting. But since the presidential inauguration, we’ve seen rates fall back. So far, the rate moves have been benign. They’re still hovering 4.5% to 4.75%. The question is: Will they push above 5% or level down to 4.25%?

Aristotle Funds' Economic Dashboard: GDP, Inflation, Jobs and Consumer Spending

What’s the current data telling us on the Aristotle Funds' Economic Dashboard?

The economy continues to have a strong foundation. Real GDP in the fourth quarter came in at 2.3%. Nominal GDP is chugging along at 4 to 5%. Atlanta Fed GDPNow is currently forecasting 3 to 4% for the first quarter of 2025. I think that will probably come down to between 2 and 3%, and that still reflects a healthy economy. Core PCE came in at 2.8% in December, as inflation seems to be settling into this 2.5 to 3% range, which is above the Fed’s 2% goal. Consumer confidence remains stable, and the jobs market is slowing, but still steady. For more context on the jobs front, in 2022 there were two job openings for each unemployed worker. Today, that ratio is 1:1, which is close to the long-term average.

Not surprisingly, the Fed held rates steady in January. Thoughts?

The rates held steady because inflation appears to be settling, though it’s above the Fed’s 2% mark. There’s also uncertainty around the impact of tariffs and new illegal immigration policies, which have the potential to be inflationary.

The language in the Fed’s FOMC statement in January leaned hawkish, but Chair Jerome Powell’s comments were interpreted as more dovish. Do you think they’re trying to keep the boat steady?

Absolutely I do. And again, that has to do with the uncertainty of how new policies from the Trump administration are going to affect the economy on the inflation and economic front.

Fed Futures: Accelerating Timing of Rate Cuts: Cuts Expected into July 2025

Can you get more specific on how the prospect of tariffs changed the calculus of Fed rate cuts?

It’s given the Fed a reason to pause. If there are increased tariffs, it’s going to increase end-costs, and U.S. growth is likely to slow marginally. Because of this, you’re seeing long-term rates settle in a bit. Meanwhile, short-term rates are staying a bit more defensive due to inflation concerns. If you look at impacts of sizable new tariffs—which haven’t gone through yet, it should be noted—I would expect exports  to decline because there will undoubtedly be retaliatory measures. This means investment and employment will decline. I think we would see short-term inflation and a longer-term slowdown in growth.

So, why would we impose increased tariffs?

For one, government tax receipts will increase if we’re taxing imports from other countries. There’s also reciprocity—if they tax our goods, we should tax their goods. Another incentive is that we want to onshore American jobs, but that requires a long-term view on tariffs in my opinion. For businesses to set up infrastructure and hire workers, there needs to be a persistence of policy. I think that’s what markets and companies are wrestling with. We see the short-term goal—we want to negotiate a better deal for our companies and incentivize American jobs. But long term, to shift investing from international to domestic, you need these tariffs to be sticky. I think it’s very difficult for a company to underwrite how sticky the tariffs will be in the years ahead.

President Trump is now in the third week of his term and busy signing executive orders and assembling his cabinet. Can you unpack some of this?

In the first two weeks of Trump 2.0, as I call it, President Trump signed 45 executive orders. For comparison, in the first two weeks of Trump 1.0 in 2017, he signed only seven. I think that shows a more focused and urgent agenda for Trump’s second time around. In case you’re wondering, President Biden signed 25 executive orders in his first two weeks in 2021. Among the most economically impactful executive orders Trump has signed were one that allows energy exploration and production on federal lands; another that ramps up efforts to stop illegal immigration; a third that looks to eliminate government barriers to AI innovation in the U.S.; and a fourth designed to promote investment in cryptocurrency and financial technologies. Those are significant initiatives, but we’ll have to see how they play out.

What about Trump’s Cabinet?

The makeup of this cabinet is roughly split between those from the business community and those from the political establishment, which is consistent with 2017. It is also among the youngest cabinets in three decades, and it is one of the wealthiest cabinets ever with all the high-profile business leaders.

Trump's New Cabinet and the Economy: Who Might Impact the Economy the Most?

Others to Watch

Besides the 15 cabinet members, what Trump nominees or appointees could have the most impact on the economy and markets?

I’d start by grouping three of them together: SEC Chair Paul Atkins, FTC Chair Andrew Ferguson, and David Sachs, White House AI and Crypto Czar. They are all considered to be pro business, pro cryptocurrency, and pro deregulation. The Trump administration is leaning into those areas.

And then there’s the wildcard, Elon Musk, who heads the unofficial Department of Government Efficiency (DOGE). He’s looking to cut $2 trillion from the almost $7 trillion federal budget. That’s aggressive and has been controversial. To reach this goal, DOGE has already gained access to the Treasury Department’s payment system to see where the money’s going. They’ve also recommended shutting down USAID, which delivers $40 billion annually in humanitarian aid overseas. And thousands of government employees are being offered severance packages under the specter of layoffs. Among these measures, I think the one to closely watch is the monitoring of payments within the federal bureaucracy. Musk has deputies setting up systems to track what’s being spent and on what, so it’s going to be interesting over the next year.

Which nominee or appointee do you think is going to have the most impact on our industry?

I think Paul Atkins at the SEC, but I could argue Treasury Secretary Scott Bessent or FTC Chair Andrew Ferguson. Their deregulatory bent should have a great impact on our industry. For example, the FTC will undoubtedly allow more mergers and acquisitions, which will help open up capital.

Fixed-Income Yields and Year-to-Date Returns

Now let’s talk bonds. Where do you see opportunities for fixed income today.

I’ve been constructive on floating-rate loans for several years now. Last year, returns were over 9%. In 2023, the asset class returned 13.3%. And in 2022, when investment-grade bonds were down 10%, floating rate was down less than 1%. It has done its job for the past three years. Because interest rates, inflation, and economic growth have been more uncertain, I don’t think rate volatility will lessen. I do believe we’re at the higher range of fixed rate. Now there are many folks thinking the 10-year Treasury will get to 5%. Others are saying it will go to the low fours or high threes. In the past year, I’ve been wrong in predicting where the rates were going, but I’ll say this. With bank loans, I think you can be largely immune from rate volatility, clip a good coupon and still be rewarded for risk by getting 8 to 9% yields.

On the investment-grade side, if we have a slowdown, you have the potential for total return. In my view, investment grade is probably above coupon given a two-year time horizon.

Let’s switch gears and go to the random round. I’ll give you a word or phrase, and you tell me what comes to mind. First one: DeepSeek.

This one’s interesting. It potentially forces many companies to rethink CapEx for AI. DeepSeek is being touted as a significantly less expensive and more energy efficient machine-learning model, which rivals ChatGPT for performance. I think DeepSeek represents the beginning of a competition to see who will emerge to be the primary AI wrapper. Essentially, large language models may be commoditized quickly..

Japan raising interest rates in January.

They did it and got away without blowing up the yen carry trade.

What do you think is going to be the best sector in the S&P 500 this year?

The easy answer is tech, but I am going to take a different stance and go with REITs. I believe rates are at the higher end, and there does seem to be more of an urgency to go back to office.

Any good podcasts you’re listening to?

I’m loving “Plain English” with Derek Thompson. He has very smart takes and guests covering a wide range of current events.

What are you watching?

“Severance” is next on my list.

Let’s close with a personal reflection.

We’ve recently been interviewing many young candidates for entry-level jobs or summer internships. I have to say I have not been impressed with some of the folks we’ve interviewed. I’ve been asking myself, “Why is that the case?” It’s not that I expect them to tell me what the 10-year Treasury is going to do or pitch an investment idea.

But I do expect them to do three things: a) prepare by studying what our company does; b) bring good energy; and c) follow up with some sort of thank you. I think the energy and follow-up parts are easy. What takes a bit of work—maybe just two hours or so—is to research and understand the company they’re applying to. It seems basic, but I’ve been surprised at the number of candidates who don’t do the minimum. My advice: prepare, bring good energy, and follow-up.

Definitions

The 10-year Treasury note is a debt obligation issued by the U.S. government with a maturity of 10 years upon initial issuance. It pays interest at a fixed rate every six months and pays the face value to the holder at maturity.

The 10-year Treasury yield is the interest rate the U.S. government pays to borrow money for a decade.

The Atlanta Fed’s GDPNow is a forecasting model that provides a "nowcast" of GDP growth.

Bank loans (or floating-rate loans) are financial instruments that pay a variable or floating interest rate. A floating rate fund invests in bonds and debt instruments whose interest payments fluctuate with an underlying interest rate level.

Basis points, otherwise known as bps, are a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form.

A bond is a fixed-income instrument and investment product where individuals lend money to a government or company at a certain interest rate for an amount of time. The entity repays individuals with interest in addition to the original face value of the bond.

Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment.

The Consumer Confidence Index (CCI) is a monthly report that measures how optimistic consumers are about the economy, labor market, and their finances.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.

A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.

A dove prefers an interest rate policy that is more accommodative to stimulate spending in an economy.

Duration is often used to measure a bond’s or fund’s sensitivity to interest rates. The longer a fund’s duration, the more sensitive it is to interest-rate risk. The shorter a fund’s duration, the less sensitive it is to interest-rate risk.

Fed funds futures is a tool used by traders and institutions to hedge or bet on changes in the federal funds rate, which is key to U.S. monetary policy.

The federal funds rate is the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight.

The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve System that determines the direction of monetary policy and is responsible for raising or lower interest rates.

Fixed income refers to assets and securities that pay a set level of income to investors, typically in the form of fixed interest or dividends.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. The nominal GDP growth rate compares the year-over-year (or quarterly) change in a country’s economic output to measure how fast an economy is growing. Real GDP is GDP adjusted for inflation.

A hawk is a policymaker and advisor who favors higher interest rates to keep inflation in check.

High-yield bonds are debt securities, also known as junk bonds, that are issued by corporations.

Investment grade refers to the quality of a company's credit. To be considered an investment grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's.

The Personal Consumption Expenditures Index (PCE) is a measure of consumer spending and includes all goods and services bought by U.S. households. Core PCE excludes the prices of food and energy.

A real estate investment trust (REIT) is a company that owns and manages income-producing real estate. REITs are a way for people to invest in real estate without having to own property themselves.

Risk is defined in financial terms as the chance that an outcome or investment's actual gains will differ from an expected outcome or return.

Spread is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, represented by treasury bonds. Spread income refers to the additional income from this difference.

The CBOE Volatility Index, or VIX, is a real-time market index representing the market’s expectations for volatility over the coming 30 days. Investors use the VIX to measure the level of risk, fear, or stress in the market when making investment decisions.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security.

The yen carry trade is a strategy where traders borrow money in Japan (in yen) at a lower interest rate, exchange it for U.S. dollars and then invest those dollars into assets that could give them a larger return.

Yield is the income returned on an investment, such as the interest received from holding a security.

A yield curve plots the interest rates of bonds that have equal credit quality but different maturity dates.

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Any performance data quoted represent past performance, which does not guarantee future results. Index performance is not indicative of any fund’s performance. Indexes are unmanaged and it is not possible to invest directly in an index. For current standardized performance of the funds, please visit www.AristotleFunds.com.

The views expressed are as of the publication date and are presented for informational purposes only. These views should not be considered as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment or market. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are subject to change without notice as market and other conditions warrant.

Investors should consider a fund’s investment goal, risk, charges and expenses carefully before investing. The prospectus contains this and other information about the fund and can be obtained at www.AristotleFunds.com. It should be read carefully before investing.

Investing involves risk. Principal loss is possible.

A full list of holdings can be found at www.aristotlefunds.com and are subject to risk and to change at anytime. Any discussion of individual companies is not intended as a recommendation to buy, hold or sell securities issued by those companies.

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