Key takeaways

  • In the third year of President Joe Biden’s term, the economy is maintaining slow but steady growth in the face of elevated inflation and higher interest rates.

  • While it’s been a contentious year in Washington with a Republican-led House often facing off against a Democratic-led Senate and White House, markets appear to be little moved by ongoing political conflicts.

  • Investors appear to be more focused on issues such as the Fed’s future policy plans, progress on reducing inflation and the strength of corporate earnings.

President Joe Biden is now well into the third year of his current four-year term of office. Since President Biden assumed office in January 2021, the economy has experienced periods of strong growth followed by more modest growth, higher inflation that has leveled off in recent months, and rising interest rates. The jobs market remains particularly strong, with the nation’s unemployment rate hovering near 50-year lows.

Through this period, capital markets produced mixed results. Stocks, as measured by the benchmark S&P 500, gained 28.7% in 2021 as the U.S. economy grew at its fastest pace since 1984. However, rising inflation and the Federal Reserve’s (Fed) aggressive response to it, including significant interest rate hikes, took a toll on stocks in 2022, with the S&P 500 losing 18.1%. In 2023, stocks gained more than 20% in the first seven months of the year but gave back some of those gains in August and September.

Source: U.S. Bank Asset Management Group.

Bond markets began to face pressure in early 2022 as the Fed’s policy stance shifted. Yields on the benchmark 10-year U.S. Treasury note, which were below 1% at the outset of 2021, rose as high as 4.81% in September 2023. While bonds generated negative total returns in 2022, returns have been relatively flat in 2023.

While it’s been a contentious year in Washington with a Republican-led House often facing off against a Democratic-led Senate and President, markets appear to be little moved by the ongoing political conflicts. Investors appear to be more focused on issues such as the Fed’s future policy plans, progress on reducing inflation and the strength of corporate earnings.


Early legislative successes

During the first two years of his term, President Biden was successful at implementing many, but not all of his legislative initiatives. In the first months of the new administration, Congress managed to narrowly pass President Biden’s $1.9 trillion American Rescue Plan, COVID-related financial relief package aimed at individuals and businesses. Later in 2021, a $1.2 trillion infrastructure investment package was enacted. In August 2022, the Inflation Reduction Act gained narrow Congressional approval and was signed into law. It included significant spending on green energy projects, gave Medicare the ability to negotiate prices on some drugs for seniors, and implemented a new minimum 15% tax on corporations. In late 2022, Congress passed the SECURE 2.0 Act, which provided enhancements designed to encourage more retirement savings and protect the savings already accumulated by retirees. It also included some provisions designed to reduce the tax burden, primarily on older Americans.


More legislative roadblocks

2022’s midterm elections changed the legislative landscape. While Democrats maintained narrow control of the Senate, Republicans won a slim majority in the House.

“With power split between two parties, there’s little that’s expected to happen in the way of legislative initiatives over the second half of Biden’s term,” says Kevin McMillan, head of state and federal government relations at U.S. Bank. “Bills put forward by the Republican House will be killed in the Democratic Senate, and vice versa.”

“Historically, when we have split control of Congress, capital markets tend to respond favorably.”

Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management

“Historically, when we have split control of Congress, capital markets tend to respond favorably,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. Markets did perform better in the first seven months of 2023, but Haworth notes the impact of the partisan makeup of Congress is unclear. “Improved market performance may have also reflected the upward market trend that began in October 2022.”

While legislative achievements were limited in 2023, Congress and President Biden struck a deal in June to suspend the nation’s borrowing limit, often referred to as the debt ceiling. That avoided a government shutdown. Another shutdown was avoided at the end of September when Congress passed a 47-day extension to allow for further work on the fiscal 2024 federal budget. Following that action, House Speaker Kevin McCarthy was removed from his position when he lost backing of a small number of Republicans. The party became bogged down in the replacement process, which brought House business to a standstill in October. “The expectation today is that the process of approving a final budget will continue to get drawn out,” says MacMillan.


Interest rates and the economy remain a major factor

Markets have turned much of their focus to the Fed and its dramatic, inflation-fighting actions. In March 2022, the Fed ended its so-called zero interest rate policy on the short-term federal funds rate it controls. Through July 2023, the Fed raised interest rates by 5.25% and had, much earlier, ended its long-standing program of monthly Treasury and mortgage-backed bond purchases. The Fed’s new monetary policy direction greatly altered the investment landscape. “Low interest rates and a policy of buying Treasury and mortgage bonds were a big support for investors prior to 2022,” says Haworth.

The Fed’s actions appeared to have the intended effect of slowing the economy and tempering inflation. The nation’s Gross Domestic Product (GDP) grew at a rate of just 2.1% in 2022, a markedly slower pace than the 5.9% level achieved in 2021. In the first and second quarters of 2023, annualized GDP measured 2.2% and 2.1% respectively.1 Inflation, meantime, dropped from a peak of 9.1% for the 12 months ending in June 2022 to 3.7% in September 2023,2 although not yet down to the Fed’s targeted inflation range of 2%.

A key question is if the Fed can slow the economy without tipping it into a recession. The state of the economy often becomes a critical talking point as an election approaches. While the 2024 election may become a consideration for investors, “markets aren’t likely to pay close attention to its potential impact before the summer of 2024,” says Haworth.


Positioning portfolios today

It’s important to note that a number of factors contribute to market performance, and it’s not strictly a reflection of the individuals who wield power in Washington. Regardless of the political environment in Washington, it’s important to keep a big-picture perspective.

Depending on one’s goals and time horizon, today’s investor might consider:

  • A neutral allocation across fixed income, equities and real assets. The risk-reward dynamic has improved as 2023 progresses, highlighted by resilient consumers, a healthy labor market and stabilized corporate profits.
  • Within fixed income portfolios, tax-aware investors may wish to consider a modest allocation to high-yield municipal bonds. For non-taxable portfolios, a meaningful investment in non-government agency mortgage-backed securities may be appropriate.
  • Investors seeking to manage total portfolio duration may wish to consider longer-maturity U.S. Treasury securities.

Regardless of how events play out, a sound investment strategy is to focus on a properly diversified portfolio that is attuned to your goals, time horizon and feelings toward risk.

Have questions about the economy, the markets and your finances? Your U.S. Bank Wealth Management team is here to help.

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  1. U.S. Bureau of Economic Analysis, “Real Gross Domestic Product and Related Measures: Percent Change From Previous Period,” Sep. 29, 2023.

  2. U.S. Bureau of Labor Statistics, “Consumer Price Index Summary, September 2023,” Oct. 12, 2023.

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