Last week, the Federal Reserve raised rates- the third increase since the financial crisis. Yet, despite world economic growth and the stock markets surging since President Trump’s election (until yesterday), the Fed is still cautious about the future.
The world economy has been picking up. The Economist reported last week that “today, almost ten years after the most severe financial crisis since the Depression, a broad-based economic upswing is at last underway.” This is a big change from the early months of 2016 when stocks were down 10% or more due in part to anxiety about China’s economy and related plunging raw material prices. Fortunately, China, through controls and stimuli, turned things around and by the end of 2016, China’s nominal GDP was growing again.
At the same time, global manufacturing has gotten stronger. Factories are much busier in the U.S., Europe and Asia. Taiwan and South Korea are rocking. Worldwide equipment spending is up; growing at an estimated annualized rate of 5.5% in 4Q16. American companies, excluding farms, added 235,000 workers in February. The European Commission’s economic-sentiment index is at its highest since 2011. Japan, whose growth has been anemic, has revised their 2017 forecast from 1% to 1.4%.
The stock markets have, until yesterday, risen dramatically based on both current economic growth stats and expectations about the future. With Mr. Trump’s election, there has been hope that taxes and regulations will be reduced which would help businesses and increase corporate profits. Further, the expected return of $1 trillion of untaxed cash held overseas by American companies could be coming back (repatriated) at new low tax rates. These funds could produce a big boom in business investment. And, then add to this the possibility of a $1 trillion private-public infrastructure push for America. Mr. Trump has been talking about growth of 3.5-4%. There’s been lots of optimism.
Yet, Fed officials forecast growth of only 2.1% this year; about where it has been for 8 years. So, what’s their cause for relative skepticism?
The list of concerns includes fears about protectionism stifling trade, political disruption in Europe, China’s ability to sustain strong growth, and closer to home, whether or not the White House and Congress can work together to get legislation passed. If the repeal of Obamacare gets sidetracked, there is concern that tax reform and infrastructure will endure the same fate. And, of course, we haven’t even talked about a black swan- an unexpected event of large magnitude and consequence. All bets are off in the case of major problems such as war, terrorism or some other major catastrophe.
We could be on the precipice of a new era with the cutting of taxes and regulations and a huge infrastructure boom creating a turbocharged economy. Or, we could have a repeat of the many times in the past decade when optimism at the start of the year faded as the year progressed. No one knows what the future holds.
Yesterday’s stock market declines of roughly 1% were, in large part, a concern about the ability of the White House and Congress to enact their legislative agenda, starting with the repeal of Obamacare. People are nervous that if the health-care bill doesn’t pass or gets delayed, what will that mean for other policies. Tax cuts could be delayed and even face a tougher fight in Congress. Treasury Secretary Steven Mnuchin had earlier thought that tax reform would pass Congress by August and now he is hoping for early next year. And, infrastructure would come after that.
With all of that in mind, the Fed understandably is cautious and we at DWM are as well.