May – 2018 Newsletter

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Index | Month/Year to Date

Dow Jones +0.34%/-1.61%

S&P 500 +0.38%/-0.36%
NASDAQ +0.07%/+2.68%
10-Yr Treasury yield was 2.73% at the end of March and 2.95% at the end of April

 

Markets

The dramatic market volatility I discussed in last month’s newsletter continued throughout April as the yield on the 10-Year Treasury rate topped 3 percent for the first time since 2014. Fears of rising interest rates and inflation helped drive the volatility along with uncertainty about how aggressive the Federal Reserve might be in its efforts to “normalize” monetary policy under new chairman Jerome Powell.

Though Powell took a “dovish” tone in an April speech in Chicago and expressed optimism that inflation will stabilize at around 2 percent, Wall Street remains nervous.1 That’s because some analysts believe there are several factors that could push inflation higher than the Fed’s target—and even Powell has admitted that if that happens, it could force the Fed to “raise short-term rates too quickly and cause a recession.”2

One potential inflation driver being cited is the Trump administration’s new tax code. Most economists believe it will add to our record-high federal deficit despite the Trump administration’s insistence that the tax cuts will pay for themselves with 3 to 4 percent GDP growth. Most economists are also skeptical about that level of growth, and it seems the Fed is too. Following their March meeting, the Fed adjusted their forecast for 2018 GDP growth from 2.5 to 2.7 percent and slightly raised the 2019 expectation to 2.4 percent. However, they projected that growth is likely to cool further after that, with the 2020 forecast holding at 2 percent and the longer-run measure at just 1.8 percent.3

While the fears around inflation and rising interest rates are most likely largely overblown for a number of reasons (which have been discussed in previous newsletters), the stock market might continue to respond dramatically to the mere prospect of high inflation and rising interest rates. In other words, fear itself will continue to drive volatility and increase the risk of the next major market correction.

Also, don’t forget that Trump’s goal of 4 percent GDP growth has already been priced into the market based on optimism. So, even if he manages to deliver on all his promises, the best the stock market could probably do is stabilize or notch just slightly higher. And, again, the Fed’s growth projections for the next few years are well below 4 percent, which means if growth doesn’t rise to meet the overpriced market, the market may finally have to shrink to align with growth.

  1. Jim Tankersley, “Powell Touts Economy’s Strength in First Speech as Fed Chief,” The New York Times, last modified on April 6, 2018, https://www.nytimes.com/2018/04/06/business/economy/powell-federal-reserve-economy.html
  2. “Fed Chair Debuts Before Congress,” Scotsman Guide, last modified on March 1, 2018, https://www.scotsmanguide.com/News/2018/03/Fed-Chair-Powell-debuts-before-Congress/
  3. Jeff Cox, “Fed Hikes Rates and Raises GDP Forecast Again,” CNBC, last modified on March 21, 2018, https://www.cnbc.com/2018/03/21/fed-hikes-rates-by-a-quarter-point-at-chair-powells-first-meeting.html
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