- Inflation Fears Are Overblown
- Business Owners Are Optimistic
- Looking Ahead
Despite talk of tariffs and trade wars, Russian assassinations, cabinet shakeups and the occasional doom-and-gloom headline, stock and bond markets have been relatively calm and collected. We say “relatively” because the day-to-day market volatility that returned last month has remained quite evident throughout March. That said, at least the recent volatility has tilted to the upside; the S&P 500 has returned 1.3% this month even with the declines earlier in the week.
As we wend our way through the next few weeks, investors will have to combat the rumors and ill-founded commentary that masquerade as advice in today’s high-speed media environment. We continue to believe that the U.S. economy remains in the Goldilocks realm of low interest rates and low inflation, and combined with wage growth that has yet to translate into increased consumer spending, we’re seeing no hard evidence that the U.S. or global expansion is about to reverse course into recession.
For the year through Thursday, the Dow Jones Industrial Average has returned 1.2%, while the broader S&P 500 has gained 3.2%. The MSCI EAFE index, a measure of developed international stock markets, is up just 0.2%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.16% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 1.9% for the year.
Inflation Fears Are Overblown
The Federal Reserve has long said it wants inflation at 2.5%, as measured by the Consumer Price Index (CPI), or at 2.0% using its preferred bogey, the Personal Consumption Expenditures (PCE) index. (Each gauge measures the change in prices of a basket of consumer goods and services.) So what are these indexes telling us? This week, CPI data showed headline inflation in February running at a 2.2% year-over-year rate, higher than the same time last year, with core CPI—which excludes volatile food and gas prices—coming in at 1.8%. All of this despite the January increase in incomes that sparked worries inflation was about to run rampant. (We’ll get the PCE numbers for February at the end of the month, but the January year-over-year headline and core rates were 1.7% and 1.5%, respectively.)
What happened? For one thing, auto sales have remained sluggish, as the post-hurricane buying hangover hasn’t worn off. And one month’s jump in incomes, influenced in part by 18 state legislatures raising minimum wages at the start of the year, isn’t a sign that inflation is aflame. Continuing low unemployment, holding steady at 4.1% for the last five months, and inflation running just below the Fed’s targets will mean that Wall Street can now focus on “too many” Fed interest-rate hikes as their inflation bugbear du jour.
We think worries of Fed hikes and inflation are misplaced. Having some inflation in the economy is a good thing. And the Fed has already indicated we could see three (and possibly four) rate hikes this year. We’ll most likely get a 0.25% increase in the fed funds rate to a range of 1.50%–1.75% next week after the central bankers’ scheduled two-day meeting concludes Wednesday. So what? Even four 0.25% hikes would put the benchmark borrowing rate at 2.50%, or less than half of the average over the last 60-plus years.
Business Owners Are Optimistic
Small businesses owners—a critical engine of employment and thus consumers’ ability to propel growth—have noticed the positive trends. In February, their reported confidence in the state of business and the economy was the second-highest in the 45-year history of the National Federation of Independent Business survey, just below the 1983 record. The tight labor market is the only component of the index in decline, another of the “growth problems” you’ll sometimes hear us mention. When the economy is at full employment, it’s harder to find qualified workers without raising wages; 31% of small business owners reported having to pay more, the highest rate since 2000.
Count homebuilders among the optimists. With housing prices climbing and a multi-decade low supply of previously owned homes unable to sate the demand of deep-pocketed consumers (another growth problem), homebuilders are feeling cheery. While down slightly from December, when builders reported the highest confidence since 1999, the National Association of Home Builders cited growing consumer demand and confidence in the market behind its rosy outlook. Indeed, consumers haven’t been put off by rising mortgage rates; applications for new home purchases rose 4.6% in February compared to a year ago. The main challenge the builders foresee? A lack of suitable lots for new construction.
Next week, the Federal Reserve is scheduled to meet Tuesday and Wednesday; analysts at CME Group, a derivatives marketplace, forecast a 94% probability of a rate hike being announced as a result. The meeting will also conclude with Fed Chair Jerome Powell’s first press conference. While Powell & Co. will obviously be the center of attention next week, we’ll also get reads on existing and new homes sales, leading indicators and durable goods orders.
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Please note: This update was prepared on Friday, March 16, 2018, prior to the market’s close.
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