Investment Commentary –September 25, 2018

Year to Date Market Indices as of Market Close September 25, 2018
Dow 26,492 (7.17%)
S&P 2,915 (9.05%)
NASDAQ 8,007 (15.99%)
Gold $1,205 (-9.28%)
OIL $72 (23.76%)
Barclay Bond Aggregate (-1.52%)
Fed Funds Rate 2.0% (last increase was 6/13/18)

The Powell Fed can make history if it can slow the economy without crashing it

The Federal Reserve has a chance to do something no U.S. central bank has done before, if it can slow the economy and raise the unemployment rate without pushing the economy into recession, said Peter Hooper, chief economist at Deutsche Bank Securities.

“The Powell Fed can make history by engineering a soft landing from below,” Hooper said in an interview.

At the moment, the unemployment rate is 3.9%, below the 4.5% level the Fed believes the “natural rate” of unemployment or where inflation neither slows down or speeds up.

All this comes at a time when there is increasing talk on Wall Street about a possible recession for 2020 or 2021, Hooper said. Such talk is natural given the economic expansion is the second-longest in history at 36 straight quarters, he said.

Read: Fed has to start considering the risk of a recession, former governor says.

Signals of investor concern about the outlook are one reason the yield curve — the difference in yield between the long TMUBMUSD10Y, +0.15% and short TMUBMUSD02Y, +0.35% ends — has flattened, he noted. Concern about the outlook is holding down the long-end of the yield curve as the Fed raises the short end.
Hooper said the Powell Fed has several factors going for it in its bid to make history.

First, there is no significant overhang of investment in durable goods or related financial imbalances to exacerbate any downturn. Secondly, the Phillips curve seems to be relatively flat, meaning the tight labor market is not causing inflation to flare. This allows the Fed to raise interest rates gradually. Third, the U.S. economy is less sensitive to oil market shocks.

Recession fears remain, at the moment, a small dark cloud in the horizon. With the economy growing at a fast clip and the labor market still tightening, the Fed is expected to keep raising rates at a gradual pace later this week and to signal more rate hikes ahead. Talk of a recession is not likely even to enter the Fed’s official forecast, even though the central bank must extend its projections out to 2021, Hooper said in the interview.

“I don’t think there will be any hint in the 2021 numbers,” Hooper said.

See: With its last easy decision, Fed will try to avoid adding fuel to the fire.

Even if the Fed were unable to avoid a downturn, the factors that gave the central bank a chance to make history, should make any recession that does occur “mild and brief,” Hooper said.

New records: Further signs of positive economic momentum helped send most stocks to solid gains for the second week in a row, although growth stocks and small caps lagged. The S&P 500 topped its record set in late August, while the Dow’s weekly gain of more than 2% sent that index above a record established in late January. The NASDAQ slipped.

Fed ahead: The U.S. Federal Reserve Board is widely expected to approve another increase in short-term interest rates when it concludes a two-day meeting on Wednesday. If the Fed decides on another quarter-point increase, it would be the fourth rate hike in 10 months and the third this year.

Global rally: The strong weekly performance for stocks extended to key international markets, with a Chinese index surging more than 4% to record its strongest weekly gain in more than two years. Indexes in Europe also climbed.

Trade catalyst: The United States and China imposed new tariffs on one another, but financial markets appeared to react positively overall. The tit-for-tat moves were more measured than expected, with the United States imposing tariffs of 10%—for now—on $200 billion in Chinese goods, rather than 25% penalties.

Around the web:
Other Notable Indices (YTD)
Russell 2000 (small caps) 12.02
EAFE International -0.03
Emerging Markets -10.02
Shiller Annuity Index 14.82

The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investments.