Normalizing Today, Overshooting Tomorrow
A strong economy is likely to embolden the Fed to raise rates at a faster pace than the market is expecting.
The U.S. economy continues to expand at an above-trend pace. Real gross domestic product (GDP) grew at an annualized rate of 3.0 percent in the third quarter, similar to the 3.1 percent pace seen in the second quarter, despite a roughly 1 percentage point drag from several major hurricanes. We also expect fourth-quarter growth to be near 3 percent, supported by strong momentum in the United States and abroad, favorable financial conditions, and rebuilding activity in the wake of recent storms. We see potential upside risks to 2018 growth in the event that tax cuts pass in Washington.
Fed Rate Hikes Are Set to Continue as the Fed Overshoots Its Dual Mandate Goals
We expect the Fed to resume a quarterly pattern of rate increases in December, hiking four more times in 2018 as unemployment and inflation overshoot on a net basis the Fed’s dual mandate objectives.
Source: Haver Analytics, Congressional Budget Office (CBO), Guggenheim Investments. Data as of 10.11.2017. Combined dual mandate shortfall adds the deviation of core PCE inflation from the Fed’s 2 percent objective and the deviation of the unemployment rate from the CBO’s estimate of the natural rate of unemployment.
Meanwhile, the labor market is steadily tightening and is in the early stages of overheating. This is evidenced by the fall in the unemployment rate to a cycle low of 4.1 percent in October. Hurricane activity distorted payroll employment in September and October, but job growth has averaged 169,000 per month in the year through October, underscoring the robust—and unsustainable—underlying trend in hiring. Although average hourly earnings data have been noisy, other indicators of wage growth, such as the employment cost index, continue to trend higher, confirming that the wage Phillips Curve is not defunct. Leading indicators, including hiring intentions surveys, point to further declines in the unemployment rate.
Inflation continues to be well below the Fed’s 2 percent target, with core personal consumption expenditure (PCE) inflation coming in at 1.3 percent in September. However, inflation lags GDP growth by about six quarters; because growth has accelerated over the past year, and the dollar has depreciated, inflation will likely move closer to 2 percent later in 2018.
We expect the Fed to resume a quarterly pattern of rate increases in December, continuing until late-2019, as unemployment and inflation are likely to overshoot on a net basis the Fed’s dual mandate objectives. Four hikes in 2018 would be a much faster pace than the market is currently pricing in, and we expect the result to be a bear flattening of the Treasury yield curve. The rise in shorter-maturity yields should outweigh any steepening pressure coming from the decline in net demand for long-duration bonds as the Fed balance-sheet runoff ramps up and European Central Bank (ECB) tapering takes effect. The appointment of Jerome Powell as Fed Chair does not change our bear flattening view, as he is likely to continue the policy direction that is currently in place.
Net Central Bank QE Purchases Are Likely to Fall Sharply Over the Coming Year
The rise in shorter-maturity yields should outweigh any steepening pressure coming from the decline in net demand for bonds as the Fed balance-sheet runoff ramps up and ECB tapering takes effect.
Source: Haver Analytics, Guggenheim Investments. Data as of 10.30.2017. Note: Monthly rate of net bond purchases by the Federal Reserve, European Central Bank, Bank of Japan, and Bank of England at current exchange rates. QE = quantitative easing.
—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Director
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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.
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January 24, 2019
Amber Lights Flash at Davos
Should the mood this year at Davos prove once again to be a contra-indicator, this may be the signal that the economy is likely to re-accelerate soon and that the party in risk assets continues.
January 18, 2019
Up the Escalator, Down the Elevator
An uptick in corporate defaults in 2019 will mark the beginning of a prolonged period of stress in the corporate bond market.
January 16, 2019
10 Macro Themes to Watch in 2019
Ten charts illustrate the macroeconomic trends most likely to shape Fed policy and investment performance in 2019 and beyond.
Global CIO Scott Minerd and Head of Macroeconomic and Investment Research Brian Smedley provide context and commentary to complement our recent publication, “Forecasting the Next Recession.”
Anne Walsh, Chief Investment Officer for Fixed Income, shares insights on the fixed-income market and explains the Guggenheim approach to solving the Core Conundrum.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
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