Fiscal Policy Giveth, Monetary Policy Taketh Away
Investors should focus on credit quality amid further spread tightening as tax cuts take effect.
The performance of the global economy exceeded expectations in 2017, with growth accelerating and the expansion becoming more synchronized across countries. U.S. real gross domestic product (GDP) growth came in at 2.5 percent in 2017 (Q4/Q4). We forecast an even faster pace for 2018, girded by strong global momentum, supportive financial conditions, and an additional boost from tax cuts and federal spending increases. Corporate profit growth will also get a jolt from the tax cut, though some highly leveraged companies will be hurt by the new limits on interest expense deductibility.
While GDP growth has been tepid during this expansion, there is a growing risk of the economy running too hot, thanks in part to fiscal easing. The labor market is already in the early stages of overheating, with the unemployment rate at a cycle low of 4.1 percent in December. We see the unemployment rate ultimately falling to 3.5 percent, and expect that a tight labor market will nudge wage growth higher.
The fly in the ointment is core inflation, which remains below the Fed’s 2 percent goal on a year-over-year basis. Recent data have been firmer, however, with core consumer price index (CPI) inflation having accelerated to a 2.6 percent annual rate in the six months ending in January.
Core Inflation Has Recovered from the Abrupt Slowdown in Early 2017
Core inflation remains below the Fed’s 2 percent goal on a year-over-year basis. Recent data have been firmer, however, with core CPI inflation having accelerated to a 2.6 percent annualized rate in the six months ending in January.
Source: Haver Analytics, Bureau of Labor Statistics, Guggenheim Investments. Data as of 2.15.2018. Shaded area represents recession. CPI = consumer price index.
Notwithstanding this uptick, some Fed officials remain concerned about the persistence of below-target inflation in recent years. Their caution can be seen in the Fed’s interest rate projections, which as of December showed a decline in the average number of rate hikes forecast for 2018 as some officials shifted their rate hike expectations into 2019. Curiously, this occurred despite a 0.8 percentage point cumulative increase in the median GDP growth forecast and a 0.2 percentage point drop in the median unemployment rate forecast. We still see four hikes in 2018 as opposed to the Fed’s baseline of three, reflecting our expectation for a steeper drop in unemployment this year, financial conditions that have eased in spite of Fed tightening, and a more hawkish Federal Open Market Committee composition.
The yield curve should continue to bear flatten as a result, driven by an outsized increase in shorter-term yields. With our work indicating that the next recession is about two years away, and with credit having richened further since the passage of tax cuts, we believe this is an opportune time to upgrade portfolio credit quality.
With Inflation Low, Some Fed Officials Want to Postpone 2018 Hikes
Average Number of 25 Basis-Point Rate Hikes Projected by Fed Officials, by Calendar Year
Some Fed officials remain concerned about the persistence of below-target inflation in recent years. Their caution can be seen in the Fed’s interest rate projections, which as of December showed a decline in the average number of rate hikes forecast for 2018.
Source: Federal Reserve Board, Guggenheim Investments. Data as of 1.17.2018.
—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Director
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
Brian Smedley, Head of Macroeconomic and Investment Research, and Portfolio Manager Steve Brown share their outlook for the third quarter 2020.
Brian Smedley, Head of Macroeconomic and Investment Research, discusses major trends likely to shape markets this year.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.
Investing involves risk, including the possible loss of principal.
*Assets under management is as of 09.30.2020 and includes leverage of $14bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC.
Guggenheim Investments. All rights reserved.
Research our firm with FINRA Broker Check.
• Not FDIC Insured • No Bank Guarantee • May Lose Value
This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.