FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

  • Investor sentiment remained upbeat this week, with U.S. equities looking to end the week on a positive note for the seventh consecutive week despite some profit taking.
  • Domestic data was relatively robust this week. Economic growth was revised up to a robust 3.5% during the third quarter, with the economy looking to expand by close to 2% during the last quarter of 2016. Sales of existing home rose to a nine-year high in November, while personal income remained flat last month.
  • Our outlook for 2017 calls for growth of just over 2%. This should be enough for the economy to eat-up any remaining slack, with the ensuing wage pressures helping lift inflation closer to the Fed’s 2% target.s aftermath.

 

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ECONOMY TO ENTER 2017 ON A SOLID FOOTING

It has been quite an eventful year to say the least. The Dow finished last year at 17,500, after taking in stride the first Fed hike in nine years. It then proceeded to plunge below 16,000 by mid-January as anxiety over the Chinese economy mounted with worries over the global economy pushing oil down below $30 in February. And just as markets found their footing during springtime, the Brexit referendum stunned investors once again. By late summer, over $13 trillion in government debt was trading at negative rates. By early autumn, investors had tacitly accepted the mediocrity of global growth as a status quo and were increasingly writing off inflation as a phenomenon of years’ past, leaving bonds in high demand and equities somewhat directionless. But, Financial News- Chart 1 many of those notions have been upended in recent weeks. The election of Donald Trump in the U.S. has rapidly altered the market landscape. Investors have shunned bonds and gold in favor of equities. Long-term yields surged 70 basis points from election night, while the Dow has been flirting with the 20,000 threshold – up nearly 2,000 after six consecutive weekly gains. Overall, despite some profit taking this week, investors appear optimistic for 2017 despite the significant uncertainty that remains as far as new policy initiatives are concerned. The new administration is still in the process of being formed, with the reins not officially passed for four weeks, and much policy is yet to crystallize.

As we look towards the New Year we believe there are a few key themes that should increasingly play out during 2017. Overall, we expect 2017 to be a year which is characterized by: increased emphasis on fiscal policy, an inflection point for interest rates, continued U.S. dollar strength, firmer commodity prices, and plenty of volatility to go around – both internationally and domestically.

What is certain is that Donald Trump will inherit an economy that’s doing quite well. Data released this week indicated that the U.S. economy grew by 3.5% during the third quarter and is on pace to expand 2% in the fourth. However, this strong pace of expansion is unlikely to be maintained through Financial News- Chart 2 2017. Despite one-off export strength last quarter, net exports look to remain a drag on growth during 2017 given the greenback rally. Moreover, dollar strength and elevated uncertainty is likely to weigh on business spending, although the diminishing drag from the energy sector and resilient U.S. consumer should help lift investment next year. On a more optimistic note, residential investment should fare well despite higher interest rates, with existing home sales looking to end 2016 with a bang.

Overall, while we believe the higher dollar and interest rates will take some steam out of U.S. economic growth next year, we expect the economic expansion to remain resilient at just above 2%. This will enable the economy to continue eating up whatever slack remains, with the ensuing wage pressure helping lift inflation closer to the Fed’s 2% target. Given the monetary tightening that has already taken place, we expect the Fed to proceed cautiously going forward. While our projections for one hike are well shy of the market expectations and the Fed’s own ‘dots’ which suggest three hikes, we’d like to remind the readers that those same dots telegraphed precisely four hikes for 2016 – and we all know how well that projection turned out.

Michael Dolega, Senior Economic

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