Quarterly key points
- U.S. GDP growth finished 2017 on a solid footing, with Q4 growth registering a +2.9% annualized pace; the economy grew +2.3% overall for 2017.
- The job market remained hot in the first quarter of 2018, with employers adding an average of 202,000 new jobs per month.
- The Fed raised its policy rate by 25 bps at its March meeting and stuck to its call for a total of three hikes in 2018.
- While global growth remains solid overall, incoming data suggests that weaker consumer and business investment may put a damper on U.S. GDP growth in the first quarter.
- Growing uncertainty over U.S. trade policy and the prospect of a tit-for-tat trade war with China risks dampening growth and souring investor confidence.
- Despite continued strong fundamentals, investors should be mindful that the global economic cycle is in the late stages of expansion.
U.S. Economy Finishes 2017 on Solid Footing
The U.S. economy grew at a solid pace in the fourth quarter, advancing +2.9% over the prior quarter on an annualized basis. For the full year, GDP growth measured +2.3%. GDP growth in Q4 was driven by solid personal consumption (+4.0% q/q annualized) and business investment (+6.8%). On the negative side, inventories and net imports were drags on growth.
Despite a weaker than expected payrolls number in March, employers still added an average of 202,000 jobs per month over the quarter. The unemployment rate stands at +4.1%, while the broader “U-6” underemployment rate fell to 8.0% in March. As a measure of just how much the job market has strengthened, the measure of unemployed job seekers per job opening across the entire economy fell to just 1.1 workers per opening in January, from a cycle-high of nearly 6.6 workers per opening in July 2009.
Consistent with a tighter labor market, most measures of wage growth are beginning to register steady gains in excess of the rate of inflation. Average hourly earnings rose 2.7% y/y in March, while the Atlanta Fed’s Wage Growth Tracker showed median wage growth advanced at a 2.9% pace (q/q annualized) in February.
Stocks Crack with Higher Interest Rates, Volatility Soars
Stocks began the year by vaulting to record highs. Over the first three weeks of January, the S&P 500 rose nearly 7.5%, with other major indices posting similar gains. By February 8th, however, stocks had reversed course, falling over 10% from their highs and entering “correction” territory. The cumulative impact of Fed policy tightening – and the prospect of other central banks ultimately following suit – was broadly highlighted as a factor behind the selloff.
While stocks recovered some of their losses over the rest of the quarter, and the S&P 500 finished down just -0.75% for the quarter, volatility remained elevated. The VIX volatility index rose from 11 at the start of the quarter to an intra-day high of over 50 in early February before ending the quarter at 20.
Growing uncertainty over U.S. trade policy – including the fate of NAFTA and the prospect of a tit-for-tat trade war with China – also weighed on investor sentiment during the quarter. On China trade, despite both sides’ attempts at talking down the idea of a full-blown trade war, the proposed tariff actions already risk dampening growth and souring investor confidence.
In the U.S., credit risk spreads widened in sympathy with falling equity prices and the spike in volatility. Spread widening, which was initially isolated to front end maturities, had extended across the curve by the end of the quarter. Most other fixed income spread sectors followed suit in underperforming Treasuries, although to a lesser degree than corporates.
Fed Follows '18 Script, but Tweaks Forecast for 2019 & 2020
The Fed raised its policy rate by 25 bps at its March meeting, to a range of 1.50% and 1.75%. Consistent with prior forecasts, policymakers signaled they expected a total of three hikes in 2018. Importantly, with the official published forecasts made public after the March FOMC meeting, policymakers raised their median projection for the pace of hikes in 2019 and 2020. The new forecast calls for the Fed Funds rate to reach 2.9% at end-2019 (up from 2.7%) and 3.4% at end-2020 (up from 3.1%). With these upward tweaks to its “dot-plot” forecast, the Fed appears to be preparing markets for the idea of further, if not faster, policy rate normalization. Consistent with their forecasts for additional rate increases, policymakers also raised their forecasts for GDP growth, core inflation, and labor market gains (lower unemployment rate) for the next several years.
Interest rates rose in broadly parallel fashion during the quarter. The 2-year US Treasury rose 38 bps to end the quarter at 2.27%, the highest level since 2008. Meanwhile, the yield on the 30-year US T-Bond rose 23 bps to 2.97%.
While global growth remains solid overall, incoming data suggests that weaker consumer and business investment may put a damper on U.S. GDP growth in the first quarter. Meanwhile, growing uncertainty over U.S. trade policy, including the fate of NAFTA and the prospect of a tit-for-tat trade war with China, risks dampening growth and souring investor confidence.
With the U.S. economy at full employment, inflation readings will likely be more important than the pace of hiring or the level GDP growth for the Fed’s rate hike decisions this year. Recent inflation readings suggest that disinflationary pressures from one-off factors may be moderating, revealing a stronger underlying core inflation trend. Supporting the potential for faster inflation, wage growth appears to be rising well above the pace of inflation.
Overall, despite continued strong fundamentals, investors should be mindful that that the global economic cycle is in the late stages of expansion. In addition, as the Fed removes the shock absorber of excess liquidity, tighter monetary policy also creates the potential for (continued) higher market volatility.
1. Source: Bloomberg, Bureau of Economic Analysis
2. Source: Federal Reserve
3. Source: Bloomberg
The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. Graphs and tables are for illustrative purposes only. FOR INSTITUTIONAL INVESTOR USE ONLY. © Copyright Galliard Capital Management, Inc. 2018 All rights reserved. ECON01082018