A robust labor market has created more job openings than there are people looking for a job. Wage growth in May averaged 2.7 percent annually, positive but not yet at the three-percent level that could raise Fed concerns.
Rising consumer net worth helped lead in May to the year’s highest month-to-month increase in retail sales, jumping by 0.8 percent and doubling April’s 0.4 percent increase.1 Consumers account for about 70 percent of U.S. economic activity, and they’re now a powerful force in moving the economy ahead.
But not every trend is positive:
- Interest rates are inching up.
- In some parts of the country, gas has approached or risen above $3 per gallon.
- Housing is becoming more expensive, with the costs of home financing and home building materials jumping in 2018.
- Trade has become a central concern as the United States and China impose retaliatory tariffs on each other and trade issues between the United States and Canada, Mexico and Europe become contentious.
Still, consumer confidence is high, and we expect the consumer’s high level of confidence continue to be a driver of growth for some time to come.
Can anything stop the winning streak?
With the recovery entering its tenth year, two potential issues could halt the economy’s momentum:
- Rising inflation
- How the Fed keeps inflation under control
In May, the Consumer Price Index increased at an annual rate of 2.8 percent, the largest gain in more than six years.2 Rising prices are erasing some of the wage gains households are experiencing – resulting in the Fed adopting a new perspective.
At its mid-June meeting, the Fed raised the federal funds rate 25 basis points, and indicated it expects to raise rates a total of four times in 2018, up from the three rate increases it anticipated at its March meeting.
“Growth is strong. Labor markets are strong. Inflation is close to target,” said Fed Chairman Jerome Powell.
The Fed is departing from its stance over the past decade, when it kept rates at historically low levels to get the economy out of its doldrums. Now it has to manage inflation without bringing growth to a halt. We’ll be watching closely to see whether the Fed can walk this very delicate line.
Every time it has adopted an overly aggressive stance, the economy has ended up in a recession. The possibility of an overactive Fed breaking the economy’s momentum is, in our view, one of the economy’s biggest risks.
The yield curve and why it matters
We believe by year-end, the Fed’s anticipated rate increases will likely raise short-term rates to 2.5 percent. If the market reacts and pushes longer-term yields below short-term yields, that will create an inverted yield curve, an abnormal condition in which short-term rates are higher than long-term rates.
An inverted yield curve indicates the market thinks the economy is slowing down – or soon will be. Because an inverted yield curve has preceded each of the last nine recessions, the market pays close attention to the possibility of the curve going upside down.
It’s almost flat now, with 30-year Treasuries in mid-June paying slightly more than 10 basis points more than 10-year Treasuries.
With inflation ticking up, investors are looking to hedge against rising costs. Investments in TIPS, Treasury Inflation Protected Securities, increased by a record $1.7 billion in the first two weeks of June.3
Money market investments also reached a record in early June, spurred by the highest money market returns in a decade. Since rates have been low since 2008, investors were prompted to buy longer-term, and often lower quality, fixed income securities. Now that mindset is shifting, as the market is offering high-quality issues yielding around three percent, with terms as short as two to three years.
Corporate earnings show continued strength
Corporate earnings remained strong, and just as important, corporate estimates of future earnings remain positive. That seems to be easing the market’s fear of companies lowering their future profit expectations.