Some aspects of the economy are quite strong and steady, however, there are some new developments with an as yet unknown impact. What appears to be resolved is that inflation continues to retreat approaching the Feds’ goals albeit more slowly than desired. Employment and consumer spending remain steady, and together with expanding manufacturing is sustaining the economy on its current strong path. Residential and commercial construction remains steady despite a very slow resale market.
What is new this quarter is that long-term interest rates (bond yields) have begun rising sharply. The Fed sets short-term interest rates but the bond market determines long-term rates. These rising long-term rates have been putting pressure on the stock market as well raising mortgage rates to 8%. This will certainly affect the housing resale market and eventually new construction. Another effect is that without any new intervention from the Fed, the closely watched yield curve is no longer inverted but has reverted to a flat profile. The yield curve has been a historically accurate predictor of economic growth. Depending on the future path of long-term rates, the Fed may choose to reduce short-term rates much sooner than they had planned and let higher long-term rates do the hard work on inflation.
Another development of some consequence is that the fiscal and monetary cooperation between the Fed and Congress seems to have died a sudden death. A small right wing faction in Congress has removed the Speaker of the House thus paralyzing legislation because he dared to allow bipartisan votes (which passed with large majorities) on raising the debt ceiling and authorizing ongoing federal spending until a new budget is passed. They likely will not choose a new Speaker that would cooperate in future bipartisan legislation. A razor thin Republican majority in the House is being held hostage by right wing extremists backed by a solid base of Trump voters in their districts. It’s a new form of an old game of brinkmanship but which is being played within one political party. There does not appear to be an easy off-ramp for the fractured Republicans.
In the Middle East, the Levant has for thousands of years been plagued by religious and racial land wars. It is a feature of the region. The media today is saturated by the most recent eruption of extreme terrorism. It is unknowable if the war can be contained or how, or to what extent, it may grow. Although the markets in recent weeks have been weak, the downturn does not seem to be from the war, but is consistent with a response to rising long-term interest rates as described above. There is a possibility that should the war escalate further, a global flight to the safety and security of U.S. Treasuries will ensue causing those yields and interest rates to decline again. This would certainly stabilize the stock markets.
As always, we remain cautious and vigilant. Please remember that because these quarterly thumbnail sketches are very brief, do not hesitate to call me if you wish to discuss your account or our outlook in greater detail.
Very Best Regards,
Joe
Affiliated Investment Advisors 