Macro factors affecting the economy and financial markets over the next six to twelve months include U.S. earnings growth, Federal Reserve policy, tax reform and interest rates. The Federal Reserve (Fed) continues to emphasize that monetary policy will follow the data. While the pace of a policy change is uncertain, barring unexpected political or economic events, short term interest rates are expected to rise gradually over the next few years.
Much of the recent monetary policy debate has focused on the low inflation trend. While the Fed has raised short-term interest rates in the first half of the year, credit has generally gotten easier, suggesting that there is more work to do in order to get the economy on a more even scope. Fed Chair Janet Yellen has said that the federal funds target rate is not far below what would be considered a ‘neutral rate’. However, the neutral rate is expected to rise over time as the economy improves – hence, an outlook of gradual policy rate increases. Officials have emphasized that the federal funds target rate will remain the main policy lever. The near-term outlook remains constructive for the stock market.
The equity markets are the quietest they’ve been in nearly half a century. With “quiet,” referring to a lack of volatility, namely the degree to which markets fluctuate up or down daily. Generally, more excitable stocks and market indices are perceived to be riskier.
Despite the fear that the markets are overvalued and a pullback or correction is inevitable, the general health of the equity markets appears positive. It’s important to manage your investments to the appropriate risk profile to ensure that proper safeguards are in place to protect your assets if and when the equity markets unexpectedly turn.
Persistently low inflation and continued expansion of global central bank balance sheets suggest a sharp rise in government bond yields is not imminent. Flow of central bank money and low inflation are the key drivers of sovereign yields.
The real risk to the bond market, and capital markets in general, is the buying stampede in credit, and, as corporate indebtedness continues to climb, risk premiums grind tighter. The tax-free market is benefiting from a highly favorable supply/demand equation.
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While the loss of life and structural damage are tragic, the economic impact of the recent hurricanes is expected to be temporary. The loss of the economic activity may shave a few tenths of a percentage point from 3Q17 GDP growth, but we should see a rebound in 4Q17. The Federal Reserve (Fed) has begun to unwind its balance sheet. The run-off will start slow, but the pace will pick up over the next four quarters, and should have a limited impact on the markets (somewhat higher long-term interest rates). Fed officials continue to expect gradual increases in short-term interest rates, with policy actions remaining data-dependent.
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