A surprisingly positive year

Week ending Friday December 29th 2017

Equity markets ended the year at highs – helped by a two-week run of weakness in the USD. The broad USD index is now back below its two year lows, hinting at easier monetary policy ahead. Contra any such conclusion we have seen bond markets also had a good year, a surprising result given healthy equities but less given such weak inflation readings. Worldwide RGDP appears to be the healthiest in years even if not yet making up to trend levels. No major currency bloc seem to be lagging, except perhaps the UK. Our own market-influenced NGDP growth forecast for late 2018 is also at highs, below the 5%+ we would like to see but handily above 4%.

The yield curve is still flashing a very modest warning as it comes closer to inversion, and did, in fact, invert around the 5 year term in the OIS markets at one point during the week. That said the flattening is at higher levels than were seen across the curve around a month ago, a positive sign. Flat curves are normal in a healthy economy but at 4-5% rates and at steady 5% NGDP growth rates – not the flaky 3-4% rates seen over the last several years in the era of obsessive 2% inflation targeting.

Fiscal policy

The tax reforms were passed to a bit of a yawn. Large corporates do not pay high rates of tax thanks to smart tax planning and they will still not pay much in future. To the extent that domestically focused small and mid-sized firms pay lower tax rates, then net profits may be higher but the benefits may be passed on in terms of lower prices if markets are competitive.

Lower tax rates may encourage greater activity, paying for themselves in terms of higher tax take. Laffer-like, but cannot raise NGDP growth unless monetary policy eases. Lower inflation rates would then be the outcome, causing the Fed even more issues in reaching its 2% Core PCE Price Inflation target.

If the tax cuts merely lead to higher deficits then the Fed may have to act, assuming Congress doesn’t act first, closing down the government. It could be an interesting few months ahead.

New broom at the Fed

The confirmation of Jerome Powell is the next big issue to watch, especially any clue as to his real views during the hearings to come. It would seem he is going to be more pro-growth than Yellen if he follows the raft of other Trump appointees. The filling of various vacancies on the Fed Board could alter that view. Marvin Goodfriend’s appointment, if confirmed, would seem to tilt the Board more hawkishly.

Data ahead

News was very light last week thanks to the holidays. Next week sees many important surveys for December and the final month payrolls. October and November seem to have been strong and no surveys have indicated any dramatic drop off in December. The final quarter growth should thus be good too. Not great, just good.


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