May 11, 2018

Economic Outlook May 2018

In this month's Economic Outlook, Chief Investment Officer Greg Sweeney gives perspectives on Federal Reserve policies, expectations for interest rates and inflation, and what's going on in national and global markets.

Federal Reserve Monetary Policy

The Federal Reserve raised the Fed funds rate March 21 from 1.5 to 1.75 percent, while also indicating future rate increases were expected due to the economy’s strength and the prospect for increasing inflation. The implied probability of a rate hike in June is currently at 93 percent, according to Bloomberg.

Inflation

The most recent year-over-year inflation rate is 2.4 percent. We anticipate it will drift higher through the next three months and then level out for the final quarter of the year. We initially expected it to reach 2.6 percent, but it could peak a bit higher.

Economic Activity

First-quarter gross domestic product (GDP) grew 2.3 percent. By comparison, GDP growth in the final quarter of 2017 was 2.9 percent. The consensus is consumers were regrouping during the first quarter, and growth moving forward should be a bit more robust. We feel that additional growth would have to come from increasing employment or rising salaries and wages rather than additional debt, which is already high.

The flat yield curve, which shows little difference between short-term and long-term rates, is keeping market watchers on edge. While a flattening yield curve has preceded each recession, not all flat yield curves lead to a recession. It is not wise to make investment decisions solely on the shape of the yield curve without considering other relevant information. Market watchers are also nervous that the U.S. economy has entered the second-longest expansion in history, suggesting the economic expansion may be closer to the end than it is to the beginning. But that’s how new records are set. There are no indications suggesting economic growth will be interrupted by a dip below zero any time in the foreseeable future. Maybe this will turn out to be the longest economic expansion in history.

The current environment has some economists thinking conditions may be present for stagflation – an economic scenario of rising prices and slowing growth.

Fixed Income

The 10-year U.S. Treasury bond yield continues to flirt with 3 percent. Bond prognosticators see sustained interest rates above 3 percent as the end to the decades-long bond bull market.

Is the writing already on the wall? The Fed suggests two or three more rate increases this year, which usually means continued rising pressure on longer-term rates. If long-term rates rise and remain elevated, it is a good sign that bond investors feel the economy will continue to expand. If long-term rates reverse course and move lower, that is a sign of the opposite.

Stock Market

At the current pace of volatility, the S&P is on target to have 100 daily moves throughout the year that are plus or minus 1 percent. With subdued volatility for much of the past several years, recently awakened instability has provided a bit of an edge to an otherwise benign stock market. The four developing factors that contribute to the volatility are elevated stock valuations, debt levels, economic growth questions and central bank liquidity reductions.

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View previous Economic Outlook newsletters.