TSG Quarterly Commentaries


ECONOMIC OUTLOOK: FIRST QUARTER 2017

CURRENT CLIMATE

FIXED INCOME INVESTMENT TEAM

POSITIVES

 

New Administration

There’s a new sheriff in town and the markets are wondering what programs President-elect Trump will champion and how successful he will be in implementing those programs.  The world is learning the impact of the President-elect’s tweets on companies, countries, and societal events.  Welcome to the new world.  Thus far, the agenda includes pro-growth policies such as lower corporate taxes, the ability to repatriate funds from abroad, infrastructure spending, less regulation, as well as the potential for border/tariff taxes, healthcare reform, and limitations on immigration. 

2.5+% Economic Growth

The U.S. economy continues to chug along, but improved confidence since the election has the left the markets with a more positive growth tone; one which projects higher interest rates and inflation expectation.  The fuel behind this growth is what has the fixed income markets tentative.  The pro-growth policies mentioned above may have negative implications for the bond market as lower taxes/less tax revenues leads to a higher fiscal deficit and an increased supply of Treasury bonds, causing Treasury yields to move higher. Corporate tax reform (i.e. lower rates and the possibility of  the removal of the deductibility of interest payments) could potentially dampen the amount of corporate debt issued, making it more attractive relative to other fixed income asset classes.  Repatriation of cash overseas, if used for debt reduction, could, at least temporarily, increase the demand for corporates, but may also encourage debt-funded M&A.  Expectations of higher growth have also extended internationally.  The days of global central banks providing liquidity may be closer to ending than was thought just a quarter ago.  Growth typically breeds increased spending and higher rates and this cycle should be no different.

Employment

As the US economy moves closer to being fully employed and as incomes increase, spending from both corporations and consumers are likely to be strong.  As the pool of available workers shrinks, inflationary pressures could result from increasing wages.  The consumer sector is likely to benefit.

Household Formation

Increased worker confidence and supportive assumptions for incomes have led to improving household formations.  This environment is a positive for the housing industry, while less regulation (albeit it may be several quarters out) may offset some of the dampening of higher interest rates on the mortgage market.  Higher rates reduce the attractiveness of refinancing, potentially limiting supply of mortgage paper in the market. Further, as the Fed moves to tighten monetary policy, their policy of reinvesting portfolio cashflows back into the mortgage market is likely to slow and then cease.  This action will remove a large player from this sector and spreads would likely underperform relative to other sectors.

NEUTRALS

 

Federal Reserve Policy

At the conclusion of the Federal Open Market Committee’s December meeting, their Summary of Economic Projections was released suggesting three increases in the Fed Funds rate in 2017 (and we concur).  This year’s FOMC composition will be slightly more dovish than last year’s committee; however, the uncertainties of the new administration’s policies will make their and the markets job much more difficult.  Assuming the pro-growth policies continue to gain momentum, higher rates and a flatter 2s-10s yield curve appear likely.

China Growth

As one of the leading global growth economies, the Chinese economy remains complex as it relates to the fixed income markets.  Recently displaced as the largest holder of US Treasury debt (due to a weakening currency), their commitment to certain asset classes, such as commodities, cannot only move markets, but impact the financial condition of certain companies and sectors.  As a producer and consumer, their influence on the global economy remains key.  We continue to expect their economy to grow, but are cognizant of the role domestic policies (capital outflow limits) may have on growth.

NEGATIVES

 

Dollar

The current global environment would suggest the dollar is biased to move higher; U.S. rates are expected to increase, while global rates are largely unchanged.  Further, with several elections in Europe scheduled for later this year, a flight to quality benefiting the USD cannot be ruled out.  On the other hand, the incoming administration’s trade protectionism, tariff, and immigration policies give rise to uncertainty.  This story will continue to develop.  A stronger/higher dollar is bad news for exports and corporations with higher overseas revenue.

Trade Uncertainty

The incoming administration has made it known that keeping jobs in America and bringing them back is a primary focus.  Further, trade agreements may be at risk and tariffs may significantly impact corporate financial conditions.  This uncertainty will bring volatility to the markets.

European Union Stability

Stability or growing instability?  With the U. K.  expected to invoke article 50 later this quarter, and upcoming elections in France, Germany, and the Netherlands, uncertainty prevails.  Risks to country-specific growth will remain until certainty can be determined.  The volume of merger activity involving companies in this area is likely to be negatively impacted.

 

The Swarthmore Group Home About The Swarthmore Group The Swarthmore Group Team The Swarthmore Group Investment Strategies Contact The Swarthmore Group The Swarthmore Group Site Map The Swarthmore Group Client Resources Client Service Quarterly Commentaries