PMC Weekly Review - August 25, 2017

A Macro View – Jackson Hole Jenga: Balancing Growth, Interest Rates, and Inflation Objectives​

Financial market leaders from around the world assembled in Jackson Hole, Wyoming this week, amidst a pristine backdrop of the snow-capped Teton Mountains and glacial blue, trout-filled lakes. The theme of this year’s agenda is ‘Fostering a Dynamic Global Economy,’ as central bankers contend with evaluating global growth and determining the correct policy options to put in place. Much like a game of Jenga, they seek to strike a delicate balance to keep their economies advancing forward. The strong building blocks of indicators, like high consumer confidence and low unemployment, weigh against the considerations of potential potholes, such as tepid inflation and geopolitical uncertainty.

Among the most widely anticipated remarks from the figureheads in attendance are those of Federal Reserve Chair, Janet Yellen, and European Central Bank President, Mario Draghi. Investors are listening closely for clues that may help determine whether the Federal Reserve (Fed) remains on track to raise interest rates in December. Leading into the Summit, Yellen was not expected to veer meaningfully from New York Fed President, William Dudley’s, remarks on August 10, reinforcing the Fed’s gradual approach to tightening and expectations of a modest rise in inflation during the second half of the year. Similarly, Mario Draghi was not expected to stray significantly from his prior guidance, but also is being watched closely for signals related to the timing of winding down the ECB’s $2.6 trillion bond-buying program. Earlier this summer, he had suggested that ‘reflationary forces’ had been introduced in the Eurozone but that a ‘considerable amount’ of monetary support was still needed for inflation to stabilize.

The US stock market, for its part, has continued to soar. Like a fast-rising skyscraper on Manhattan’s illustrious skyline, the market has continued to climb at an unprecedented pace since its March 2009 lows. New records have been reached and then set again, as indices broach their all-time highs only to surpass them later. The Dow Jones Industrial Average peaked at an intra-day high of 22,179 on August 8, and appears poised to break it again in short order, particularly if Trump’s tax reform goes through. The Dow has since given back some of its gains, but rallied nearly 200 points on Tuesday on such hopes, as investors displayed enthusiasm toward a Politico news story regarding the administration’s strides on tax legislation and infrastructure spending.

Tax reform has certainly been a defining point of President Donald Trump’s political campaign, and the market has rallied considerably on its prospects. Should additional headway be made in October, some speculate that the Dow could approach 30,000. Although this very thought may make some investors lightheaded, the rally could have legs when considering the additional economic value tax cuts could bring in terms of job creation, heightened infrastructure spending by small businesses, and repatriation of corporate profits overseas. Additional revenue also may be generated by capping the mortgage interest deduction. Nonetheless, whether Trump can deliver on either of these promises remains to be seen. Any new legislation will certainly face hurdles in terms of budget considerations, lobbying by special interest groups, and progression through both the House and Senate.

Although the stock market’s strength has little bearing on monetary policy, Trump’s tax cuts, if enacted, could have a tangible impact on boosting gross domestic product (GDP). This growth, in turn, theoretically could offset potential cutbacks in borrowing related to higher interest rates—further exacerbating the inflation (or lack thereof) dilemma. One challenge facing central bankers in both Europe and the US is that inflation remains inexplicably low and has not kept up with the growth in the labor markets, leaving both economies operating well under their 2% targets.

So, by some measures, our towers are exceedingly high, and many investors are questioning whether we can bear the weight of another beam. However, as history reminds us, a loose block will not necessarily disturb the rest of the structure if the foundation is otherwise solid, and there are many reasons to believe that the US economy is reasonably sound. Unemployment is low, the dollar is strong, and consumer sentiment is high. Additionally, the Federal Open Market Committee (FOMC) has shown a commitment toward supportive monetary policy, and any tightening is likely to be well thought out, thoroughly vetted, and deliberately slow in execution. 

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