HIGHLIGHTS
- Stocks snapped a two-week winning streak, as monetary and fiscal policy announcements grabbed center stage. The S&P 500 closed in the middle of the recent trading range.
- The new Fed Chairman raised market concerns of the possibility of four rate hikes instead of three, and President Trump announced plans to impose 10% and 25% tariffs on aluminum and steel, respectively.
- The economic backdrop remained solid, with better than expected personal income growth, but also accelerating inflation.
- Coming Week: The “tariff tantrum” debate will likely continue and raise market concerns about global retaliation. It’s also jobs week, and the market is looking for a 200,000 increase in payrolls with a modest drop in the unemployment rate to a new cycle low.
Stocks snapped a two-week winning streak as monetary and fiscal policy initiatives grabbed center stage. The S&P 500 closed in the middle of the recent trading range.
The S&P 500 closed -2% lower, as worries about a more aggressive Federal Reserve interest rate policy were compounded by a Trump plan to impose tariffs on imported steel and aluminum, which sparked fears of a trade war. The S&P 500 finished 4.3% above the early February low, but -6.7% below the January high; nearly in the middle of the recent trading range. All eleven sectors declined, though tech and telecom stocks were relative outperfomers. Bond yields rose on rate hike worries, but then fell after the Trump announcement to finish the week mostly unchanged. Commodity prices also fell, but the value of the dollar rose, in contrast to recent months.
The new Fed Chairman raised market concerns of the possibility of four rate hikes instead of three.
In his debut as Federal Reserve Chairman, Jerome Powell’s prepared remarks suggested a continued gradual approach to future interest rate hikes. But while he deftly dodged most of the leading questions during his testimony, he did suggest that recent economic strength might justify additional interest rate increases. The market raised the odds of a fourth short term rate hike to 35%, and the value of the dollar received a boost.
President Trump announced plans to impose 10% and 25% tariffs on aluminum and steel, respectively.
The announcement sparked fears of a trade war, as retaliation is a common reaction to this type of aggressive policy. Barclays estimated the potential drag on economic growth was a mere -0.1% to -0.2%, hardly sufficient to derail the current expansion. That said, responses often target politically sensitive sectors that have the greatest influence and leverage on key members of Congress. Bourbon and Harley Davidson motorcycles are reportedly in the crosshairs.
The economic backdrop remained solid, with better than expected personal income growth, but also accelerating inflation.
The economic calendar was relatively full, but only a few reports had any notable market influence. In particular, personal income in January rose by a better-than-expected 0.4%, and real disposable income, adjusted for inflation, rose 0.6%, suggesting the recent tax cuts lifted take-home pay. Momentum is a key metric for analysts, and the three-month annualized increase in real disposable income accelerated to 3.4%, compared with a more modest 2.3% increase over the past twelve months. Moreover, the Federal Reserve’s preferred inflation measures also accelerated in January, with the headline Personal Consumption Expenditures Deflator (PCE) rising at a 2.9% annual rate over the past three months and the “Core” PCE (excludes food and energy) accelerating to a 2.1% annual pace: both above the Fed’s long-term 2% target. In addition, the ISM Manufacturing Index rose above estimates to a very healthy 60.8. The Atlanta Fed estimates that first quarter growth is running at a 3.5% annual rate. The key takeaway is that economic growth shows widespread signs of accelerating, which should be positive for sales and earnings, but it also may increase the odds that the Fed may have to raise short term interest rates more than expected this year.
Coming Week: The “tariff tantrum” debate will likely continue and raise market concerns about retaliation. It’s also jobs week, and the market is looking for a 200,000 increase in payrolls with a modest drop in the unemployment rate to a new cycle low.
The evolving market challenge in 2018 is that, while economic growth and earnings are likely to accelerate, market valuations are already somewhat elevated, suggesting investors have discounted at least some of the expected improvement. We also appear to be seeing three emerging forces that may prompt investors to temper their elevated expectations: accelerating inflation, a more aggressive Federal Reserve and a looming trade war.