Paul Single                          Steven Denike
Managing Director                Portfolio Strategy Analyst  
(415) 576-2531                       (212) 702-3500


  • The big question for the markets is, “How will the Powell Fed differ from the Yellen Fed?”
  • The unemployment rate continues to fall, reaching a cycle low of 4.1%
  • It appears that inflationary pressures hit a low point this past summer and are starting to rebound
  • In the past year, the pace of domestic manufacturing has picked up

What a difference a year makes. Following a shocking string of populist victories in the U.S. and Europe, 2017 began amid a post-election haze of uncertainty. Anti-globalist movements seemed to be in ascendance with a turn towards nationalism and protectionist trade regimes threatening international stability. Yet, 12 months later, economic growth has surprised to the upside almost everywhere around the world, and many of the risks that once loomed over the near-term outlook have receded.

In the U.S., despite backing out of the Trans-Pacific Partnership and taking some potshots at “unfair” trade deals, the new president's main focus thus far has been on health care, tax cuts and deregulation. Likewise, Brexit has not had the huge adverse effects on the UK that many anticipated. At this point, it looks like there will be no major changes in the rules governing the UK's economic relationship with the EU until mid-2021 at the earliest, and even then we believe they will probably be small.

Nor has Brexit so far heralded similar types of political upsets in the rest of Europe. Rather, in the wave of elections that followed, nationalism seemed to lose a bit of its momentum. In France, for example, Emmanuel Macron won a presidential election victory on a new type of pro-globalization social contract, and his early efforts have focused on the kind of labor-market reforms most other European countries had begun to enact years ago.

Considering where we started the year, the anti-globalization movement has so far proved to be surprisingly muted. International trade has actually accelerated, stock markets have hit record highs, and measures of financial risk remain unusually low. Business and consumer optimism has soared, and with renewed momentum coming from all corners of the world, the steady economic expansion in the global economy looks set to continue for some time yet.

Europe's economy has reached a comfortable if modest cruising speed, with unemployment declining to the lowest point since the global expansion got underway in 2009. Japan, likewise, is in the midst of its longest stretch of growth in more than a decade. Meanwhile, in the developing world, China continues to defy fears of a hard landing as authorities manage the difficult transition to a lower growth but more advanced economy. Even Brazil and Russia, whose economies have been mired in commodity-driven recessions for some time, appear poised to grow again this year.

Here at home, a soft first quarter was followed by two quarters in which real activity expanded at an annual pace exceeding 3%, and early indications suggest the fourth quarter could extend this streak. Much of the recent strength in U.S. growth has been driven by the acceleration in global demand and a weaker dollar, both of which have led to a remarkable turnaround in exports over the past 12 months. However, stronger corporate capital spending, a recovery in productivity, and a likely modest boost from tax cuts could help prolong the business cycle at least another year.

For the first time since 2010, the world economy is outperforming most expectations, and we expect this strength to continue. We believe that existing growth drivers, especially the positive momentum of employment and investment in combination with modest fiscal stimulus, should more than offset any restraining factors, such as a less accommodative monetary policy, somewhat tighter credit conditions, and moderately higher commodity prices. While risks to the global outlook still exist, threats that seemed significant just one year ago—including trade wars, instability in the EU, and a sharp contraction in China—now appear to be outside possibilities. Barring a major geopolitical crisis, the stage is set for another year of broad-based international economic growth in 2018.


EP Dec 2017 Fig 1


Jerome “Jay” Powell, a Republican who was appointed to the Federal Reserve's Board of Governors (BOG) by President Obama in 2011, has been nominated to lead the Fed. The Senate is expected to approve. Janet Yellen's four-year term as chair of the Federal Reserve ends in early February, but her membership on the BOG (a 14-year term) doesn't expire for several more years. In keeping with tradition, she will resign from the BOG when her successor is sworn in—a vote of confidence in Powell.

The big question for the markets is, “How will the Powell Fed differ from the Yellen Fed?” The general belief is that the Fed will continue the gradual raising of the federal funds rate with one more hike this year and three more next year (see Figure 2). In addition, it is expected to continue to the gradual rolling off of securities from the Fed's balance sheet. What is not known is the future makeup of the rest of the FOMC. A new Federal Reserve vice chairman needs to be appointed, along with three other members of the seven-member Federal Reserve Board. Furthermore, the New York Fed needs to appoint a new president, since Bill Dudley, a former economist at Goldman Sachs who valiantly held that position for more than eight years, is retiring. This position is always a voting member of the FOMC. These new members will have opinions on the direction of monetary policy. Although the themes are expected to continue, there is a lot of wiggle room in the pace of reducing stimulus.


EP Dec 2017 Fig 2


The unemployment rate continues to fall, reaching a cycle low of 4.1%. It has not been this low since the end of 2000. Payrolls in October jumped by 261,000, and the previous two months were revised upward by 90,000. Those revisions erased the negative number for September, so the string of monthly increases now stands at 85 months. The yearly change in average hourly earnings fell to 2.4% from 2.7%, reflecting a surge in hiring in the leisure and hospitality sector, a group that has the lowest average wage among major industries.

The U-6 report measures the unemployed, part-time workers who want full-time jobs in addition to those who have given up looking for a job. Economists like this report because it is a more comprehensive look at the slack in the labor force. It too has hit a cycle low of 7.9%, which matches the lowest reading of the previous expansion (see Figure 3). What has pushed this rate down the past two months is a plunge of 524,000 in the number of involuntary part-time workers. Impressively, this is occurring at a time when structural changes in employment have been favoring part-time positions over full-time jobs. This is more evidence that the labor market appears to have recovered from all the harsh job losses of the Great Recession.


EP Dec 2017 Fig 3


It appears that inflationary pressures hit a low point this past summer and are starting to rebound. During the period of downward pressure on prices that led to the nadir of the yearly change in CPI in June at 1.6%, the Fed stated that a confluence of one-off events was causing the disinflationary trend. This point was true, as there were a handful of category prices that overall were putting steady downward pressure on prices, most notably cell phone service plans and used cars. The Fed was confident that those pricing pressures were temporary, and that inflation would rebound toward its goal of 2.0%. Some in the markets were less certain; they were fearful of a new downward trend in inflation. It turns out that the Fed may be correct. Phone plans posted two consecutive monthly increases in prices, and used car prices, impacted by a strong demand for replacement of storm-damaged cars, posted a gain after falling during each month of the year. All of this can be seen in the three-month data of CPI, which is up to an annualized rate of 4.3% (see Figure 4).

Our expectation is that inflation will trend higher next year. Weakness in the dollar, higher PPI prices, and continued tightening of the labor market are all important fundamentals that can cause upward pressure.


IMAGE_EP Dec 2017 Fig 4


In the past year, the pace of domestic manufacturing has picked up due to a weaker dollar, steady improvements in global economic growth, and increased business confidence. There are two clear economic indicators showing this growth: the ISM manufacturing index, which has rebounded back to the high levels that occurred in the early part of this expansion, and manufacturing output (part of the Industrial Production report), which has climbed back from a yearly change of -3.3% in 2015 to a rate of 2.7%. With this resurgence, there has been an increase in manufacturing payrolls, which are up 138,000 in the first ten months of this year. That compares to a 2015 increase of just 68,000 and a 2016 decrease of 16,000. It is important to note that hiring was low during those years due to the rapid and significant decrease in oil prices.

The weakness in the dollar this year, which fell for the first nine months, along with the synchronized global economic recovery, has had a big impact on U.S. products being sold overseas. This has helped put into the positive territory the Net Exports category of GDP for each of the three quarters of this year (see Figure 5).


EP Dec 2017 Fig 5

Index Definitions

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

The ISM Manufacturing Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production, inventories, new orders and supplier deliveries.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

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