How Should We Tax the Great Wealth Transfer?

Economic

Summary:

Private transfers of resources across generations are as old as society itself.

Introduction

Private transfers of resources across generations are as old as society itself. Controversies about such transfers are equally ubiquitous, featuring prominently in biblical stories and Shakespearean plots alike. In modern times, transfers of wealth raise issues as intimate as the nature of family relations and as public as the ability of the economy to generate fair outcomes. The size and distribution of intergenerational transfers have raised concerns about creating family dynasties, exacerbating trends in inequality, and limiting economic opportunity and mobility. At the same time, there are concerns that taxing transfers reduces efficiency and capital accumulation and violates the principle of horizontal equity.

These issues will likely rise in importance over the next several decades, as the U.S. comes to grips with the largest set of intergenerational wealth transfers in its history. Taxing these flows judiciously could raise revenue and improve the tax system, but transfer taxes have been eviscerated in recent years.

In this policy brief (which is based on a more extensive research project), we develop an innovative methodology that matches bequests and inheritances. We use the results to investigate the revenue and distributional effects of three options for wealth transfer taxes: reforming the estate tax; taxing capital gains at death; and converting the estate tax to an inheritance tax (paid by recipients). We conclude that inheritance taxes can raise more revenue and be more progressive than the existing estate tax. Moreover, taxing inheritances and unrealized capital gains at death would close two of the largest loopholes in the income tax.

The Great Wealth Transfer

Coverage of the impending “Great Wealth Transfer”has already entered the public discussion. Households aged 55 and older held 71% of aggregate bequeathable wealth in 2021, up from 54% in 1997, according to Survey of Consumer Finances data. Figure 1 shows wealth trajectories by age group. Households with heads aged 55-64, 65-74, and 75 and older have seen strong wealth growth relative to GDP. Households with heads aged under 40 or 40-54 had the same or less wealth in 2021 relative to GDP than they did in 1997. Much of the increase has accrued to just the wealthiest 10% of households aged 55 and older.

If the experience of earlier generations is a guide, a substantial share of the wealth held by households aged 55 or older will be held until death—especially among the very wealthiest households. It will be bequeathed to future generations in a manner that maintains family dynasties and makes the distribution of resources among the recipient generation more unequal. In 2021, the top 10% of earners received 55% of aggregate inheritances, whereas the bottom two quintiles received less than 10%.

The need for transfer tax reform

Despite the very unequal distribution of inheritance wealth, the wealth transfer tax system—consisting of the estate, gift, and generation-skipping taxes—has been all but eviscerated over the past 50 years, including the cuts to the estate tax enacted in 2017. The share of decedents whose estate faced estate taxes has fallen from 6.5% in 1972, to 2.1% in 1997. By 2021, only one out of every 1300 people who died faced any federal estate tax, less than 0.1%. Estate tax revenues have fallen commensurately, both as a share of all revenues and as a share of GDP.

The U.S. is an outlier in the OECD, where many more countries have inheritance taxes than estate taxes. Of the 36 OECD countries, only four (Denmark, South Korea, the United States, and the United Kingdom) tax estates. Another 20 tax inheritances, all according to some combination of the relationship to the decedent and the size of inheritance received (OECD 2021). There is significant heterogeneity across countries in the wealth level that is exempt from transfer taxation, but even the highest exemption level, $1.1 million in Italy in 2007-2018, is far below the estate tax exemption in the United States. Wealth transfer taxation makes up a very small proportion of aggregate tax revenues in all countries.

Reforms to the wealth transfer tax system could reduce economic inequality and boost federal revenues. Recent years have seen substantial increases in the dispersion of a variety of economic measures including income, wealth, and life expectancy, raising concerns ranging from equality of opportunity to the future of democracy1 (Bricker et al. 2016; Saez and Zucman 2018; Smith, Zidar, and Zwick 2022; Case and Deaton 2023). Wealth transfers contribute to rising inequality as transfers in the aggregate are large, are given by the most affluent households, and are received by already-wealthy heirs (Feiveson and Sabelhaus 2018). In addition, standard budget projections imply that federal debt will rise steadily and inexorably over the next 30 years, reducing the rate of economic growth (CBO 2024, Auerbach and Gale 2024). While some adjustments will be needed on the spending side, increases in federal revenues can and should be part of the solution as well. In light of high inequality, raising tax burdens on affluent households merits special consideration, especially because the taxation of capital income has declined in recent decades.

Estate and inheritance taxes

Comparisons of the estate tax and an inheritance tax have long been a staple of economic policy analysis (Batchelder 2007). Part of the difference between the two taxes is just that there appears to be less moral outrage against taxing a large gift that someone receives than taxing the accumulated wealth of a donor. A carefully designed, nationally representative survey by economist Stefanie Stantcheva (2021) at Harvard University reports that 61% of respondents believe it is unfair to tax estates of decedents who earned their own wealth. At the same time, only 32% of respondents thought it fair that children of wealthy parents have “access to better amenities.”

An inheritance and an estate tax might also differ due to important behavioral effects. For example, if the goal of wealth transfer taxation is to reduce inequality, an inheritance tax is more effective than an estate tax because it targets large individual transfers rather than large estates, which may be divided up among several family members under an inheritance tax (Becker 2005, Fahri and Werning 2010, Piketty and Saez 2013).

Finally, a key difference between the estate tax and an inheritance tax is that the latter would cover one of the biggest omissions in the income tax: income received by gift or bequest. Taxing all income, rather than allowing different treatment of various forms of household resources, is a desideratum of good tax policy. This cannot be achieved without taxing inheritances as income.

Despite repeated claims to the contrary, there is little evidence that wealth transfer taxes reduce capital accumulation or efficiency, and they certainly can be structured in ways that take account of the special considerations raised by small businesses or family farms.

Taxing capital gains at death

Taxing previously unrealized capital gains at the death of the asset owner is sometimes referred to as treating death as a constructive realization event. How unrealized gains are addressed at death is closely related to the taxation of estates and inheritances. About 27% of all wealth and 41% of the wealth held by the top 1% takes the form of unrealized capital gains (Bricker et al. 2020). Under current law, no income tax is ever paid on the unrealized gains that occur over the owner’s lifetime if the owner holds the asset until death. Dubbed the “Angel of Death loophole,” this provision not only loses billions of dollars in revenue but also distorts behavior—individuals are incentivized to hold capital assets for their entire lifetime to avoid taxation when that capital might be more efficiently allocated elsewhere (Kinsley 1987).

This loophole can be addressed in two ways. First, under carryover basis at death, heirs would receive the asset with the original basis and, when they sold the asset, that they would be taxed on the full capital gain rather than (under current rules) just the appreciation that occurs after they receive the bequest. This approach was created in 1976 but then repealed in 1980 before it ever went into effect. The tax code currently uses this approach for assets transferred inter vivos but not for bequests. CBO (2022) estimates that implementing carryover basis at death starting in 2023 would raise an additional $2 billion in revenue in the first year and $156.4 billion over the subsequent 10 years. Several other countries—including Australia, Austria, Mexico and Norway—use carryover basis.

Alternatively, unrealized gains could be taxed at death. The best example of this in practice is Canada, which has no estate or inheritance tax but treats death as a realization event (Canada Revenue Agency 2024, OECD 2021). To address liquidity issues, Canada exempts capital gains on principal residences and provides a lifetime deduction of 1 million Canadian dollars for qualified farm and fishing property. Relative to carrying over the basis, taxing gains at death simplifies recordkeeping because individuals do not have to keep track of the original purchase price of inherited assets once the tax is paid. This advantage has not been enough to persuade other countries to adopt a tax on unrealized gains at death, however.

Recent work shows the revenue potential for taxing unrealized gains at death. Poterba and Weisbenner (2001) and Avery, Grodzicki, and Moore (2015) estimate that a tax on unrealized gains at death without any exemption level could raise more than the current estate tax system but that the tax burden would fall more on low-wealth households than under the estate tax. Avery, Grodzicki, and Moore (2015) and Gordon, Joulfaian, and Poterba (2016) estimate that if the exemption level were set at the 2010 level, when carry-over basis existed for a year, the revenue effects of taxing gains at death would be far lower than under the current estate tax. CBO (2011) comes to the same conclusion, estimating that, relative to a counterfactual where 2010 law was extended, reinstating the estate tax in 2011 raised an additional $550 billion over 10 years.

Methodology

The comparisons between an estate and inheritance tax and taxation of unrealized gains at death are of current policy interest. In recent policy proposals by seven think tanks to address the long-term fiscal imbalance, all seven proposed some reform to the taxation of wealth transfers. These reforms ranged from a complete repeal of the estate and gift tax to the reversion of estate tax parameters to 2009 levels. Four of the proposals would repeal the step-up in basis of capital gains at death, and one proposal would replace the estate tax with an inheritance tax

Our work features both a new methodology to estimate inheritances and bequests and new results. Inheritances are directly observed in the SCF, and we use a method developed in an earlier paper (Feiveson and Sabelhaus 2019) to include both the inheritances that are reported as well as transfers of real property not captured in the SCF inheritance module. In addition, we construct estimates of bequests, based on estimates of household wealth from the SCF, estimates of differential mortality risk (with respect to income) from both the Social Security Administration and from work by Chetty et al. (2016), estimates of estate tax deductions from Statistics of Income data, and estimates of estate tax liability from our own calculators. There is nothing in the model or methodology that requires that (simulated) bequests closely approximate (respondent-reported) inheritances, but the two series are reasonably close in aggregate and have broadly similar size distribution, which we take as validation of the new methodology. We believe the methodology itself is a significant advance over previous work in that it allows comparisons of bequests with inheritances as a source of validation.

By linking bequests and inheritances we are able to analyze wealth transfer taxes assuming they are borne either by decedents or inheritors, unlike previous work in the literature. Thus, we can calculate the distributional effects assuming that the burden of any of the wealth transfer taxes falls on either decedents or heirs. In this paper, however, we analyze all policy options assuming that heirs bear the burden of the tax (following Batchelder 2007, Entin 2004, and Mankiw 2003). We rank households by Expanded Income (EI), a broad measure of income we have developed elsewhere. EI includes all major forms of cash and non-cash income, including estimates of unrealized capital gains, imputed income from owner-occupied housing, unreported business income, and inheritances received.

Results

With this framework, we examine two stand-alone inheritance tax options—with a flat rate of 37% (the highest income tax rate in 2024) or 15% —and a third option, also stand-alone, to tax unrealized gains at death at a rate of 23.8% (the top rate on realized capital gains in 2024). By adjusting the exempt amounts, these options can raise the same amount of revenue as the estate tax under 2021 parameters. The exemptions are $2.81 million and $940,000 for the inheritance tax options and $2.22 million for the tax on unrealized gains. Figure 2 shows the distribution of tax burden by heir’s EI. As panels A and B show, the 37% inheritance tax is the most progressive of the options and is more progressive than the current estate tax, both because of the high rate and because of the large exemption amount that the high rate allows.

In alternative simulations, we return the estate tax to its 2001 parameters, adjusted for inflation. Remarkably, this version of the estate tax would have raised $145 billion—more than seven times as much revenue in 2021 as the actual estate tax did that year. As panels C and D show, both the estate tax and the 37% inheritance tax (with an exemption of $150,000) are quite progressive under this revenue target. Even when ranking heirs by inheritance-exclusive EI, neither impose an aggregate tax burden of more than 0.5% of EI on the bottom 90%. The 15% inheritance tax and the unrealized gains taxes are not capable of generating the same amount of revenue. We conclude that inheritance taxes can raise more revenue and be more progressive than the existing estate tax and that they have other advantages such as broadening the income tax base.

How Should We Tax the Great Wealth Transfer?_2

Conclusion

Over the next several decades, the U.S. will experience the largest flows of intergenerational transfers of wealth—in absolute and relative terms—in modern history. Taxing these flows appropriately and judiciously represents an opportunity to raise revenue, improve the vertical and horizontal equity of the tax system, bring about more equal opportunity, and reduce the role of family dynasties in the economy. The current transfer tax system, however, has been eviscerated in recent years and is ill-equipped to help society reach these goals. Despite repeated claims to the contrary, rebuilding a functional transfer tax system would not necessarily reduce capital accumulation or efficiency, and it certainly could be structured in a way that takes account of the special considerations raised by small businesses or family farms. These issues are of current interest as Congress looks for ways to close the fiscal gap. Our estimates show that thoughtful reforms to the wealth transfer tax system—including taxing unrealized capital gains at death and converting the estate tax to an inheritance tax—can raise revenue, increase progressivity, and improve the economy in other ways as well. These reforms would help impose an important backstop to collect taxes on accumulated income that is currently escaping tax free. Policymakers should take these estimates into account as they evaluate wealth transfer tax options as well as fiscal consolidation more generally.

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Warren Takunda

Economic

The dollar held firm and near recent peaks on Tuesday, on the eve of an expected interest rate cut in the United States, as traders have ratcheted long-term rate assumptions higher.

The friendless euro , which is heading for a calendar-year drop of nearly 5% on the dollar, was not far from recent troughs and traded at $1.0509 in the Asia session with markets in a holding pattern ahead of the Fed decision.

The gap between U.S. and German ten-year yields is 216 basis points and has widened nearly 70 bps in three months .

The yen was steady at 154.06 per dollar, after six straight days of selling as markets have pared chances of a Japanese rate hike this week in favour of a move in January.

The Federal Reserve announces its interest rate decision on Wednesday and interest rate futures imply a 94% chance of a cut, even as services-sector activity leapt to a three-year high according to an S&P Global purchasing managers survey.

The Atlanta Fed's GDPNow indicator is running at 3.3% for the fourth quarter and the strength of the economy has been lifting yields and supporting the dollar as traders figure that the neutral setting for rates may be higher than first thought.

Fed officials' median long-run interest rate projection was 2.9% in September. Market pricing implies almost no chance of rates being that low by December next year and only a 30% of the Fed Funds rate falling below 3.75% by the end of 2025.

The Nasdaq notched a record closing high Monday amid an otherwise mixed day for stocks as investors anticipated another rate cut

"I think the Fed will now be worried about a resurgence of inflation as an unknown policy mix and sticky prices create many paths for inflation to make a comeback in 2025," said Brent Donnelly, president at Spectra Markets.

"And therefore I think they will signal a very cautious approach going forward and lean on language that suggests concerns about inflation and a higher neutral rate."

Besides the Fed, the Bank of Japan, Bank of England and Norges Bank meet this week and are expected to stand pat on Thursday, while the Riksbank is seen cutting rates, perhaps by 50 basis points.

Sterling bounced on Monday as a survey of business activity pointed to price rises in Britain while labour data is due on Tuesday, with upward pressure on wages seen adding to the case for caution from the central bank. Sterling last bought $1.2680.

The Canadian dollar , squeezed by falling interest rates and the risk of U.S. tariffs, sank to a 4-1/2 year low on Monday as the sudden resignation of Finance Minister Chrystia Freeland put an unpopular government under more pressure.

The Australian and New Zealand dollars are pinned near the year's lows, though were spared any further selling on the latest weak Chinese economic indicators on Monday as markets bet that government spending will ride to the rescue.

The Aussie was last down 0.2% to $0.6356 and the kiwi slipped to $0.5769. New Zealand increased its bond issuance forecast for the next few years.

China's yuan was steady at 7.2845 per dollar, as dour expectations for Chinese economic growth pinned 10-year bond yields near record lows.

Chinese leaders agreed last week to raise the budget deficit to a record 4% of gross domestic product next year, while maintaining an economic growth target of around 5%, two people with knowledge of the matter told Reuters.

Source: Reuters

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Cohen

Economic

With a change of power pending, the administration intends to sell about €380 billion ($400 billion) in securities, according to a statement published Tuesday by the federal finance agency. That compares with €438.5 billion this year and a record volume of around €500 billion in 2023.

The agency plans to raise a total of €240 billion on the capital market and €126 billion on the money market, the statement said. The debt-issuance plan includes Green Federal securities of between €13 billion and €15 billion.

German bonds extended gains after the announcement, with the yield on 10-year debt falling three basis points to 2.22%.

With early elections taking place in February after the collapse of Chancellor Olaf Scholz’s three-way coalition, the issuance plan is subject to change after a new administration takes charge and adopts its 2025 budget. In the interim, government spending will be limited to legally necessary expenditures and already agreed projects.

Jörg Kukies took over as finance minster after Christian Lindner was fired by Scholz in November, when the ruling alliance failed to agree on a budget for 2025. Finance ministry officials don’t expect a regular budget until the second half of 2025 as talks to form a new governing coalition could take months.

After struggling to grow for years, the German economy is now 5% smaller than it would have been if the pre-pandemic growth trend had continued, and much of the shortfall is related to structural issues and will be tough to recover, according to an analysis by Bloomberg Economics.

Anxieties over declining living standards has contributed to an increasingly fragmented political landscape in Germany. More than a quarter of voters support fringe parties, and the far-right Alternative for Germany is second in the polls ahead of Scholz’s Social Democrats.

Source: yahoo finance

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ING

Economic

Commodity

Energy

Energy – European gas falls on easing supply concerns

European natural gas prices came under further pressure yesterday. TTF futures declined for a fourth consecutive session and settled almost 2.3% lower on the day, with front-month TTF losing nearly 18% since making a recent peak in early December. Ongoing discussions to keep Russian gas flowing via Ukraine beyond 31 December are weighing on gas prices currently. Recent reports suggest that gas buyers in Slovakia and Hungary are continuing discussions to keep gas flowing. Meanwhile, demand for gas pipeline capacity through Bulgaria and Turkey has also increased for January 2024, hinting that market participants are preparing for alternatives if Russian gas flow via Ukraine stops as scheduled.

Weather forecasts show that temperatures could turn milder across northwest Europe next week, which could provide some relief to the sharp inventory withdrawals. Liquefied natural gas imports have also increased recently, helping the region to secure fuel for heating demand. This should further help ease supply concerns in the market.

European gas storage is 78% full, down from 89% at the same stage last year and also below the five-year average of 81%. Gas prices might remain volatile over the coming weeks as higher competition from Asia for LNG creates an upside risk, while an extension of Russian flows would be bearish for prices.

Oil prices are trading little changed this morning as demand concerns from China continue following the recent release of poor economic data. ICE Brent was seen trading near US$74/bbl while NYMEX WTI was hovering just below US$71/bbl today. Meanwhile, reports that the European Union sanctioned 52 additional tankers largely shipping Russian crude offered some support for prices.

Metals – LME aluminium falls

LME aluminium three-month prices fell to the lowest level seen in a month yesterday on concerns over weak winter demand and rising output in China. The official data released this week showed that Chinese aluminium production reached record highs last month, at a time when demand is expected to experience a seasonal lull as construction activities slow during the winter months. Other base metals traded mixed as market participants await the conclusion of the final Federal Reserve meeting for the year.

Gold is trading steady, with prices holding above US$2,650/oz this morning as investors remain cautious ahead of interest-rate decisions by major central banks globally. The Fed will also disclose its final rate decision for the year tomorrow, along with an updated outlook on economic growth, inflation and unemployment for next year.

The recent official data shows that gold imports in India rose to a record high of $14.8bn (+331% year-on-year) in November as domestic demand picked up after the government reduced the customs duty to 6% from 15% in July. Additionally, geopolitical uncertainties and higher seasonal demand also helped the overall purchases to move higher.

Agriculture – Ukraine grain shipments rise

Recent data from Ukraine’s Agriculture Ministry shows that grain exports for the season so far have risen 22% YoY to 19.5mt as of 16 December, up from 16mt for the same period last year. The increase was driven by wheat, with exports rising by 37% YoY to 9.2mt. Similarly, corn exports stood at 8mt, slightly down compared to last year. However, total grain exports so far this month fell significantly by 60% YoY to 1.1mt, down from 3mt for a similar period a year ago.

The latest estimates from the Brazilian Institute of Geography and Statistics (IBGE) show that the nation’s grain, pulse and oilseed production could rise by 7% YoY to 314.8mt for the 2025 season. The growth will be driven by soybean and first-crop maize, with output seen rising by 12.9% YoY and 9.3% YoY respectively. The rise in production estimates could also be attributed to the increase in harvest area, which is expected to expand by 0.8% YoY to 79.8m hectares for the period mentioned above. Meanwhile, the agency estimates 2024 grain production stood at 294.3mt, down 6.7% YoY.

There are suggestions that the Chinese government has requested domestic traders and processors to reduce overseas grain imports this year, in its effort to support local farmers amid a slowdown in domestic consumption. Along with that, officials are taking longer than usual to do quality checks of imported beans, delaying the cargoes at the border for more than 20 days, compared to about five days under normal circumstances.

Weekly export inspection data from the USDA for the week ending 12 December shows that US corn and wheat inspections rose while soybean export eased over the last week. Export inspections of corn stood at 1,129.8kt, up from 1,058kt in the previous week and 959.9kt reported a year ago. Similarly, US wheat export inspections stood at 298.1kt, above 248kt a week ago, and slightly higher than 284.8kt seen last year. For soybeans, US export inspections stood at 1,676.4kt, down from 1,736.8kt a week ago but higher than the 1,425kt seen for the same period last year.

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Owen Li

Economic

Political

(Dec 17): South Korea’s ruling party is trying to delay the appointment of judges to the Constitutional Court in a move likely aimed at preventing the opposition from boosting the chances of ousting impeached President Yoon Suk Yeol.

The law requires a minimum of six judges to confirm Yoon’s removal. Currently there are six judges in place with three vacant seats. The opposition Democratic Party, which successfully led the campaign last week to impeach Yoon over his failed martial law bid, is looking to fill the remaining seats as quickly as possible, a move that would lower the bar for removing Yoon to two-thirds of the judges from 100%.

Kweon Seong-dong, floor leader of Yoon’s People Power Party, objected Tuesday to the opposition parties’ efforts to fill the places, contending that the nominees should not be formally appointed by Acting President Han Duck-soo even if approved. He cited a 2017 case when then Acting President Hwang Kyo-ahn refrained from appointing a constitutional judge after one justice retired in the middle of President Park Geun-hye’s impeachment trial.

DP floor leader Park Chan-dae has dismissed the argument and said his party will push ahead with the appointments. Two nominations have come from his party while the other is a PPP pick.

Four of the judges currently sitting on the court were nominated by either former President Moon Jae-in or a Supreme Court justice Moon had appointed. Among the other two, Cheong Hyungsik was a pick by Yoon while Kim Bok-hyeong was named by a Supreme Court chief the current president had appointed.

If three more judges are added to the court with the current nominations, the court would be made up of six judges who owe their appointment to Moon or his appointee and three ultimately to Yoon. Still, in 2017 the constitutional court at the time made a unanimous decision to uphold former President Park’s impeachment, despite some owing their appointments to her.

Moon has supported Yoon’s impeachment and has publicly shown support for Lee Jae-myung, the DP leader who media polls show as the favourite to replace Yoon if an election were held as a result of the Constitutional Court approving Yoon’s impeachment.

South Korea’s National Assembly suspended Yoon from power on Saturday by narrowly passing an impeachment motion against him after the president imposed a brief martial law decree on Dec 3 and sent troops into parliament.

Yoon has vowed to fight on. The South Korean president is fielding his legal defence team and denies insurrection allegations against him, Yonhap News reported Tuesday, citing Seok Dong-hyeon, an attorney who represents him.

Yoon declared martial law, claiming the need to crack down on an opposition-controlled parliament that sought to paralyse his government. An opposition coalition managed to pass the impeachment motion against him last week in a second attempt, sending the motion to the Constitutional Court for approval.

The court has until mid-June to decide on the impeachment motion and plans to hold its first preliminary hearing on Dec 27.

Source: Theedgemarkets

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FxPro

Economic

After the French snap election led to a divided government and an ungovernable France since summer, German politicians gave a no-confidence verdict for the three-way ruling party of Germany, paving the way for an early election in February – about 7 months earlier than scheduled. It means that the Germans will join their French neighbours in political gridlock and uncertainty. The energy crisis and weak global demand explain the most of the German economic misery today. The German economy could’ve grown 5% more over the past five years if it could maintain the pre-pandemic and pre-Ukrainian war trend, according to the latest research. But looking at the DAX index, you wouldn’t guess that the country is experiencing harsh economic meltdown and political problems.

The DAX index retreated yesterday, but from near an ATH level. The political shenanigans didn’t prevent the index from rallying above the 20’000 this month. Its technology heavy weights, like SAP and Siemens, followed their American peers to the north, and somehow hid the misery of the carmakers. But the same cannot be said for France. Their luxury companies could barely provide an umbrella for the rainy French days, as Chinese consumers failed to show up at the rendez-vous. As a result, the Stoxx 600 appears to be peaking ahead of what’s shaping up to be a chaotic Christmas in Europe, while the US continues to revel in the joys of life. There, the atmosphere is completely different.

The Federal Reserve (Fed) is preparing to announce an additional 25bp cut that the country doesn’t necessarily need on top of a 75bp cut delivered since September. The US stock markets are at ATH levels, home prices are at ATH, the US national debt is at ATH, the US CPI is no longer showing progress toward the 2% goal, growth is strong and jobs market looks fine. But the Fed is cutting the rates again.

The S&P500 was up yesterday, not to a record – but near, Nasdaq 100 however advanced to a fresh record high, with Broadcom gaining another 11% yesterday – on top of the 24% added on Friday post-earnings on their juicy forecast for custom AI chips. Nvidia however retreated another 1.68% and has officially stepped into the correction territory – after losing more than 10% since the November peak. The Big Tech buddies’ willingness to build their own chips is probably raising some questions among Nvidia investors as the company made half of its revenue from the Big Tech customers last quarter. Elsewhere, Bitcoin is exploring the moon and abouts on Trump optimism and as Microstrategy – which is a company that made its fortune by buying massive amounts of Bitcoin over the past years – is about to make its way to the Nasdaq 100 in December 23rd. Last week, the company sold around $1.5bn of shares to buy that amount of Bitcoin. It’s as if Bitcoin was joining Nasdaq.

Anyway, it’s all very much great, though there are rising worries about the possibility that we might be seeing a bubble in the US markets. The S&P500 hasn’t deviated from its long-term trend this widely since the dot-com bubble. But a bubble is not a bubble until it bursts. For now, Trump and Powell are giving investors all the support and the money in the world to stick with their positions.

On a side note: the big banks’ dollar expectations are rather soft. Société Générale sees the US dollar weaken 7% against the euro next year, pointing at the ballooning US budget deficit. The reality is that, we’ve been hearing about the US budget deficit for years, and yet…

In the FX, the US dollar index consolidates slightly lower than the November peak into the Fed decision, the EURUSD is waiting for a fresh direction around the 1.05 psychological mark. Released yesterday, the Eurozone December PMI numbers showed further weakness in German and French manufacturing, while activity in services looked better – certainly due to some Xmas magic. But all in all, if the Fed sounds reasonably less dovish about its policy, the EURUSD could extend losses below the 1.05 mark. Elsewhere, the USDJPY advanced to 154.50 yesterday on rising bets that the Bank of Japan (BoJ) will sit still and intervene with intervention threat. Swaps give around 20% of a rate hike this week.

Finally, in commodities, US crude kicked off the week on a bearish note, hit by disappointing news and data from China and could well return below its 50-DMA near $70.15pb – on rising global glut concerns, while cocoa futures advanced to a fresh record high on renewed concerns about the unideal weather conditions in West Africa.

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SAXO

Economic

Macro data and headlines

Germany’s Chancellor Olaf Scholz lost a confidence vote as expected yesterday and he has called for a snap election set for February 23, seven months ahead of the regularly scheduled election, only the sixth time since WWII that an election has been called early.

US services PMI hit its highest levels since October 2021 at 58.5, while manufacturing was at 48.3. Composite employment nudged above 50 for the first time since July, while new orders were at their highest level since April 2022. Price data was stable, sending a Goldilocks message once again ahead of the Fed decision this week where a 25bps cut is baked in, but 2025 path looks highly uncertain.

Eurozone PMIs also saw some improvement, mainly driven by services that rose to expansion territory at 51.4 while manufacturing was unchanged at 45.2 with both German and France manufacturing PMIs slipping further but Germany’s services PMI in expansion. Meanwhile, UK’s manufacturing PMI slipped to 47.3 from 48 in November, while services rose to 51.4 from 50.8.

Equities

US: equities posted mixed results on Monday as investors prepared for this week’s Federal Reserve policy decision. The Nasdaq 100 climbed 1.3%, surpassing the 22,000 level for the first time, driven by Broadcom (+11.2%) after reaching a $1 trillion valuation and Tesla (+6.1%). Apple (+1.1%) and Alphabet (+3.6%) also hit record highs. However, the Dow Jones fell 0.25%, marking its eighth consecutive decline, weighed down by a 4.2% drop in UnitedHealth Group. Super Micro Computer tumbled 8.2% ahead of its exit from the Nasdaq 100, while MicroStrategy edged slightly lower ahead of its upcoming inclusion.

Europe: European stocks closed lower on Monday as markets digested Moody’s downgrade of France’s credit rating and Germany’s escalating political uncertainty. The STOXX 50 fell 0.4% to 4,948, and the STOXX 600 slipped 0.1% to 516. Automakers led losses, with Mercedes-Benz, BMW, and Stellantis sliding on weak Chinese retail data. In France, the CAC 40 dropped 0.7% following the downgrade and Chancellor Macron’s nomination of a new prime minister. Meanwhile, ECB officials reiterated their cautious stance on rate cuts, as PMI data indicated continued Eurozone economic softness.

Asia: Asian markets were mixed ahead of major global interest rate decisions this week. The Hang Seng Index fell 0.9%, hitting its lowest since December 6, weighed down by weak Chinese retail sales (+3% vs. 4.6% forecast) and lingering economic uncertainty. The Shanghai Composite slipped 0.5%, while the CSI 300 edged up 0.3%, supported by gains in automakers and battery stocks. Japan’s Nikkei 225 ticked up 0.3% as markets priced in a steady policy decision from the Bank of Japan later this week. Investor sentiment across the region remains cautious, awaiting clarity on global monetary policies.

Volatility

Volatility rose ahead of central bank decisions, with the VIX climbing 6.37% to 14.69, signaling heightened market caution. Expected moves for the S&P 500 stand at 19.22 points (~0.32%) and for the Nasdaq 100 at 133.04 points (~0.60%), both showing no big expected moves for the day, based on options pricing. Notable options activity focused on Nvidia, Tesla, and Broadcom, as AI momentum and index reshuffling continue to drive market positioning. With the Fed’s rate decision and retail sales data on deck, near-term volatility remains in focus.

Fixed Income

US Treasury will auction 20-year T-notes today as long US yields as the 20-year benchmark sits near 4.7% versus the November highs just above 4.75% (and 2024 high of 4.97%).Yields in Europe rose again yesterday in the wake of the flash Dec. Eurozone PMI, which show the manufacturing economy continuing to contract at a rapid pace in France and Germany, but the Services surprisingly above 50 in both Germany and in the wider Eurozone.

Commodities

NY Cocoa hit a record high on Monday, up 181% this year, due to ongoing supply concerns in West Africa, where adverse weather hampers efforts to rebuild global stockpiles. A decade-low in NY open interest has reduced liquidity and increased volatility.

Gold drifts lower ahead of the FOMC meeting, weighed down by profit-taking after its strongest year since 2010, amid a firmer dollar, and US 10-year Treasury yields.

Live Cattle Futures approach USD 2 per pound for the first time ever, up 14% YTD, supported by the smallest US beef herd since 1961, a temporary halt on Mexican imports due to a pest issue, and potential supply-chain disruptions if Trump imposes tariffs on Mexican and Canadian imports.

Crude prices remain stuck near the lower end of a range that has persisted for more than two years and are heading for a modest loss on the year, as expectations of a glut next year and the dour outlook in China overshadow geopolitical tensions in Russia and the Middle East. Support from additional Western sanctions against Russia and Iran is being offset by a large amount of spare capacity currently held by producers.

Currencies

The US dollar mostly sideways as the focus is on CNH weakness as China appears in a deflationary spiral – with 10-year Chinese debt plunging further to new lows below 1.75% yesterday. USDCNH pulled close to the 7.30 level while AUDUSD similarly pushed on the lows of the cycle near 0.6350 this morning.The Swedish krone bolted higher on no discernible news, with EURSEK trading below 11.45 this morning and down around a percent from the levels yesterday morning. The Riksbank meets Thursday and is expected to chop rates another 0.25%Focus this week on the five G10 central banks meeting, all within 24 hours of each other and kicking off with the FOMC on Wednesday, which is seen likely to produce a 25 basis point cut, but uncertainty on the degree to which the Fed will adjust its forward guidance as much as the market has shifted since the September Fed projections on policy (market has removed about 100 basis points of easing since then).

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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