Major macro factors affecting the economy and financial markets over the next six to twelve months include trade policy, interest rates, earnings growth, Federal Reserve (Fed) policy, and geopolitical uncertainty. The U.S. economy continued to expand at a moderate rate in the first half of 2018, although growth was a bit uneven across sectors. The underlying fundamentals of the economy remain sound.
The year began with two key themes. The first was that the economy had considerable momentum in late 2017, which likely would continue into early 2018. The second was that the outlook would grow more clouded beyond the middle of the year, reflecting the uncertainty around tax cuts, demographic constraints, and tighter Federal Reserve (Fed) policy. Also, the uncertainty around trade policy can be added to this list of themes as talks on tariffs and a retaliatory backlash threaten to disrupt current trade agreements around the world. The key to the outlook is the Fed’s balancing act, as it attempts ‘a soft landing,’ where growth slows to a long-term sustainable pace.
The expansion is now the second longest on record and popular opinion says there are no signs of a recession on the immediate horizon. However, there are some challenges for the second half of the year. There is little risk of the U.S. economy entering a recession this year, but the odds are higher as one looks to next year, reflecting the possibility of a monetary policy error. Weighing all these uncertainties will make the Fed’s task of achieving a soft landing even more difficult, and the risks of a policy error are rising. However, the near-term economic outlook remains optimistic.
With focus on economic development over the past generation, China has achieved huge success. In more recent years, the Chinese have made efforts to broaden their global influence as well as their diplomatic and political roles. America has to finance its fiscal deficit in order to keep the economic show on the road, and China needs relative global economic stability in order to continue its fairly seamless rapid development. In Europe, planning for a lengthy Brexit transition period and measures to make the entire European economy more dynamic should continue to be top priorities. Despite all the negative headlines, this is still within the grasp of Europe’s policymakers. It is far better to keep full interaction with the world’s number one economy today while pushing domestic change and reform initiatives.
The pace of earnings growth should slow down in future quarters, but it is believed the market understands this and does not expect inflated earnings growth to continue indefinitely. It is unlikely that the U.S. will continue to add workers at the same pace of the past few years, which means companies will have to focus instead on productivity growth to keep the wheels turning. Investors are still gathering evidence of what companies are doing with their excess cash, but preliminary signs show some pickup in both business investment and wages. Investing in the future and improving productivity will increase the chances of continued economic expansion while helping the stock market combat rising input costs and higher expectations of today’s investors.
Economic data reports have been consistent with a pickup in the pace of growth in 2Q18 (the advance GDP estimate is de, along with annual benchmark revisions, at the end of July). Job growth has remained relatively strong, and labor market conditions have tightened further. The Federal Reserve (Fed) has continued to raise short-term interest rates, and further rate increases are expected (at a gradual pace) — as the Fed tries for a soft landing. Trade policy conflicts have intensified, adding risk and uncertainty to the outlook.