The Fed’s shift was subtle yet unmistakable – inflation is stubbornly low; U.S. earnings season could be cause for cheer; China speaks of “grey rhinos”; crude oil prices get pulled into the Venezuela crisis.
"There is now no question mark over the world economy’s gain in momentum”
The Fed and inflation: Conceding the point The July 24-25 meeting of the Federal Open Market Committee (FOMC) was mostly uneventful, as expected. But the exception was noteworthy: the subtle but clear shift in tone about the FOMC’s attitude toward the below-target rate of inflation showed increased concern that reaching the target 2% rate might prove more difficult than previously believed. The new tone was broadly in line with the U.S. bond market’s signals; the implicit rate of inflation ten years out was about 1.8%1 and hadn’t reached levels above 2% since March of this year.
The matter is more than technical; at stake is the date of the Fed’s next rate hike. Broadly speaking, the lower the inflation rate the later a hike will likely happen. Which, in turn, affects financial markets in much of the world – from emerging-market bonds to the cost of investment capital for U.S. corporations. If the current U.S. growth rate is considered fragile, later is better. But savers wishing to keep money in insured savings accounts may have a different opinion.
U.S. corporate earnings: Season’s greetings With 278 of the 500 companies in the S&P500 reporting quarterly earnings so far, results have been better than recent expectations, in both sales (1.3% better) and earnings (5.1%). While the “beat” could be the result of lowered expectations in advance of these announcements, the positive sentiment generated by this aspect of corporate news flow puts a brighter spin on the S&P500’s strong valuation of about 21.9 times current earnings and 18.5 times estimated earnings for the end of 2018.2
China: Grey Rhinos on the march China’s official media have taken to describing certain kinds of financial events not as unforeseeable black swans, but as grey rhinos,3 highly probable, high-impact threats people should see coming, but don’t. While it’s unclear precisely which issues are raising the sense of urgency suggested by this language, it’s often been mentioned, by official sources, in the same breath as the country’s burgeoning corporate, municipal and personal debt burden.
Crude oil: Linkage Crude oil markets have made a U-turn since the middle of June, with West Texas Intermediate (WTI) looking to break above $50 per barrel (bbl) and Brent breaking through to $52.42 – levels not seen since mid-April and mid-May, and then as they were headed downward instead of up. Along with the usual talk of declining inventories, an additional factor has resurfaced – a possible confrontation between the U.S. and Venezuela, as talk of embargos against the already-embattled country ratchets up both internal and external strife.