2017 Year in Review - The Data
Dec 22, 2017
The Federal Reserve (Fed) raised interest rates 3 times in 2017, each time adding 25 basis points to the lower and upper end of the range. As at December 13, 2017, the Fed’s benchmark interest rate range was 1.25% to 1.5%. The Fed has projected 3 rate hikes in 2018 while some analysts are projecting as many as 5. The Fed also started a program to reduce its balance sheet. Starting in October 2017, the Fed allowed USD10 billion per month to mature without reinvesting the proceeds. This withdraws stimulus from the economy. A robust labour market and moderate economic growth were cited as the primary drivers of the rate hikes. The U.S economy has entered its 9th year of expansion driven primarily by personal consumption. In the 3rd quarter of 2017, the U.S. economy grew at 3.3% year over year. The health of the labour market is essential in sustaining this growth. However, below trend core inflation constrained additional interest rate increases in 2017.
2017 saw rallies across U.S. asset classes. The S&P 500 has risen by 19.99% year to date, Nasdaq by 29% and the Dow by 25.4%. The U.S. equity market is trading at all-time highs, but main street analysts project that the Trump tax cuts and high levels of global liquidity will continue to buoy valuations. Almost in defiance of traditional economic theory, bond yields declined amidst rising interest rates. After the passing of U.S. tax reform, the 10 year US Treasury sold off to reach a high of approximately 2.5%. Year to date, the yield on the 10 year US treasury has risen by less than 5 basis points. Commodity prices have also experienced a boom. WTI and Brent are up 6.96% and 13.9% respectively year to date. The main variable to impact oil prices next year will be U.S. shale oil production.
The European Central Bank (ECB) remains dovish amidst improving growth but stubbornly low inflation. The ECB announced a 50% reduction in its quantitative easing program during 2017 but committed to maintain and extend it if necessary. The European economy is expanding modestly at 2.6% year over year in the 3rd quarter of 2017. Most recently, Mario Draghi referred to “movements in the foreign exchange market” as a downside risk to Euro area growth. The Euro has rallied 13% in 2017 and the ECB has implied that this could jeopardize the region’s modest growth achievements.
Unemployment in the Eurozone also remains high at 8.8% for the 4th quarter of 2017, down from 9.6% in the 4th quarter of 2016. “Structural reform” is most frequently cited as the impediment to future growth. In an October 2017 speech, Mario Draghi acknowledged labour market reform in Spain, Portugal and Italy which made “unemployment more responsive to growth”.
European equities underperformed their US counterparts, with the EURO Stoxx 50 rising by 8.5% year to date. The German 10 year bund yield is ending the week notably higher (0.417%) than where it started (0.189%).
Political risk has long been a major headwind for the Eurozone. Brexit, the recent victory of the Separatist movement in Catalonia, and Italian elections next year will remain headwinds for the region. The stock of bad loans on the balance sheet of the financial sector could also limit the pace of growth. Nevertheless, European USD corporate bonds still offer investors attractive risk adjusted return, and the early stage of recovery implies potential asset price appreciation.
While growth (0.3% in the 2nd quarter of 2017) in excess of inflation (1% in the 2nd quarter of 2017) still eludes the Jamaican economy, business and consumer sentiment appear to be positive. The low interest rates and the reduction of GOJ issuance in the local market have helped to sustain the rally in the stock market (roughly 45% year to date). The performance of the local stock market is likely to be a function of the JMD liquidity in the market (i.e. the extent of the BOJ’s open market operations). To the extent that JMD liquidity remains buoyant and public sector debt issuance low, the market is likely to continue to rally.
Marian Ross is an Assistant Vice President of Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at [email protected]