Economic Outlook: Cutting Through the Noise

Economic Outlook: Cutting Through the Noise

One year ago, the majority of investors thought the strength of the US economy would force the Fed to raise interest rates to prevent unwanted inflation. In fact, many financial experts thought Janet Yellen and the Fed were behind the curve when they raised rates in December for the first time in 10 years. Opinions are now somewhat more complicated, and economists and investors are somewhat more polarized.

On one side, you have media outlets and economists who think we’re hurtling toward a recession. On the other, you have optimists who seem to be looking at a completely different set of numbers. Today we’ll look at the big economic picture: the Treasury Yield Curve, the Federal funds rate, and inflation so you can understand the fundamentals and cut through the noise.

Yellen’s Comments to Congress

In recent testimony to Congress, Yellen expressed uncertainty about several economic factors and how they would affect the world economy, namely: global selloff in financial markets, the dropping price of oil, and the poor state of the Chinese economy. Despite increasing levels of quantitative easing, the US and European stock markets have been turbulent in recent weeks.

Historical Perspective

The US Fed has steadily injected liquidity into the US economy for the last 35 years—including a big injection in 2009 after the crash. Some are concerned that quantitative easing is having less and less impact. They say that asset prices are elevated, debt is high, and short-term bond yields are rising more than long-term yields (also known as a flat yield curve). They note that not since the Great Depression has the US had a flat yield curve with near-zero interest rates. The implication is that the Fed’s tools are no longer working and that Washington may need to step in and make changes to fiscal policy. While some point to a flattening yield curve as evidence that we’re on the edge of a recession, others aren’t convinced.

According to the chief economist at Jeffries & Company, Ward McCarthy, the curve has been flattening on and off since 2011, and by historical terms we’re still in good shape. More than anything, the decline in oil prices are to blame. Instead of signaling a recession, the graphs show us a transition into a more stable economy after a 7-year bull market.

Federal Reserve Sits on Rates, but Hints at Increases

The Federal Reserve decided not to raise interest rates in March, but indicated that they would likely raise rates two or three times this year. As we mentioned in a recent blog, the economy is currently being supported by strong fundamentals like job growth and rising wages. Unstable oil prices and global economic weakness are unlikely to prevent interest rate hikes for long. Furthermore, the unemployment rate stayed at 4.9% in February—well within the definition of “full employment.” If these positive fundamentals persist, there’s little reason to fear a recession. Though dropping oil prices may be hurting the market, they’re also putting more money in the pockets of consumers—a likely reason that spending recently increased to its highest level in 10 months.

Inflation Outlook Positive

Furthermore, on March 7th the Federal Reserve Vice Chair Stanley Fischer said he was optimistic that inflation would continue increasing at a healthy clip, allowing the Fed to continue normalizing monetary policy. The US inflation rate nearly doubled over the last year, increasing from 0.7% in December 2014 to 1.3% in January 2016, which is still short of the 2% target set by the Fed.

The Big Picture

The world of economics is a lot like the world of investing: you have many individuals with many divergent opinions. Some are optimists, some are cynics, and investors must ignore the hype and look at the underlying fundamentals. OptiFour Integrated Wealth Management can help. Our financial planners have provided financial planning and implementation, risk management, and wealth management to individuals in and around Washington, D.C. for over 25 years. If you’re interested in our unique, personalized approach to financial planning, please visit our homepage today.