TSG Quarterly Commentaries


ECONOMIC OUTLOOK: FIRST QUARTER 2018

CURRENT CLIMATE

FIXED INCOME INVESTMENT TEAM

POSITIVES

 

3.0+% Economic Growth

Domestic growth is forecasted to be better than last year as low unemployment and positive wage growth are contributing to a more confident consumer, while the new tax legislation with a much lower corporate tax rate will increase corporate earnings and make the U.S. a more attractive place for investments.  Multinational corporations with large overseas cash may choose to repatriate their profits back home for the first time in decades.

International Growth

Improving global growth has given central banks the ability to reduce the degree of monetary stimulus.  Quantitative easing programs in Europe, Canada, U.K., and Japan are either slowing or are expected to slow in the near future.  These “unwinds” could pressure risk assets at times depending on the speed with which the unwinds occur.  Brexit remains a concern but the negative impact so far has been limited to the U.K. markets.

Tax Policy

The Administration has made good on its promise to lower taxes, and many corporations and individuals will benefit, likely fueling domestic growth.  With a lower repatriation tax, a number of companies may bring cash back into the states leading to the question of what will they do with it?  Some actions will be a positive for fixed income investors (limit additional debt by leveraged companies) and some may not (equity friendly activities).  Either way, fixed income investors will have to be sensitive to the potential outcomes.  Individuals with more cash in their pockets should lead to improved confidence and the economy should benefit.

Business Optimism

Increased business confidence is likely given completion of the tax reform legislation.  Fixed income participants will be watching for how this optimism integrates into underlying businesses; expansion, acquisition, etc.  Expansion could require additional capital but access to labor could be a limiting input.  M&A is always present and could lead to additional debt issuance specifically or weakening financial conditions generally.

Consumer Spending

A historically low unemployment rate, stable to improving wages, low inflation, a rising financial market, and the recently passed tax package should lead to strengthening consumer confidence and therefore improving consumer spending.  Energy prices had found a trading range; however, more recently they have edged higher, potentially serving as a tax to consumers and possibly offsetting some of the benefit of the recently passed tax reform. 

NEUTRALS

 

Federal Reserve Policy

The Federal Reserve will have two meetings this quarter; one chaired by Chair Yellen and one chaired by Chair Powell, as he takes control of the Federal Reserve.  We don’t expect many changes during Chair Powell’s tenure, rising rates in a slow and predictable manner where the increases will be driven by economic data.  Given the information thus far, 2 to 3 increases appear likely with the yield curve likely to continue to flatten.  By most economic indications, Inflation appears to be running just shy of the Fed’s 2% target, and there don’t appear to be any suggestions of pressures increasing or decreasing materially over the near term.

Trump Administration Agenda

With tax reform behind us, the focus turns to what is next, less regulation, infrastructure, immigration, trade?  Any of these could benefit the economy; however, the fixed income markets are keenly sensitive to how the various programs will be funded.  Additional government debt could adversely impact the Fed’s ability to reduce liquidity in the market.  The administration’s policy on trade, especially if NAFTA gets renewed or repealed, could have significant impact on the economy and the financial market.

NEGATIVES

 

Immigration

With the unemployment rate near historical lows, any limitations on employers’ ability to fill openings will serve to stress an already tight resource.  These stresses could have significant negative implications for years to come until capable resources are identified and instituted.  The technology sector specifically could be at risk to see slower innovation or to see opportunities move abroad.

Cyber Threat

The risks from cyber threats are very real, as experienced by several companies, both foreign and domestic, last year.  In some cases, lost revenues were able to be made up in subsequent quarters; however, this was not the case in all events.  Further, the realized or perceived loss of intellectual property looms ever larger.  These risks will continue to plague the markets.

Geopolitical Risk

While concerns over activity in the Middle East continue, North Korea has been added to the  list of State Sponsors of Terrorism.  With the threats come uncertainty suggesting that at least some exposure to the risk free sector may be appropriate.

 

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