Wending towards Equilibrium

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There is a seeming tatonnement (trial and error process) going on in U.S. markets, as the outlook vacillates over contrasting views on the Federal Reserve, economic growth and the likelihood of recession. The flattening of the yield curve and drop in the year-over-year return on the S&P 500 are driving the negative view. Based on the shape of the yield curve alone, the New York Fed model of a recession 12 months out rose from 3% probability in December 2018 to 21% in December 2019. Such a sharp rise cannot be ignored. The strong employment data put the sharp downturn narrative into question, though admittedly labor is a lagging indicator.

On the other hand, the strong employment picture is likely to keep the Fed poised to tighten. Fair enough. As the new members of the Federal Open Market Committee get comfortable in their chairs, however, markets will focus on the FOMC message of “data dependent, not on a set path at present,” which seems to offer a counter argument to imminent tightening. This back and forth is likely to continue into the early part of 2019, but in the end, the fundamentals win out. Right now, it appears the fundamentals still include good growth and low inflation.

Please see the section on the economy, pages 58–76 of the Global Perspectives Book.

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