HIGHLIGHTS OF THE WEEK
- Investors paid close attention to developments from the White House this week, with President Trump’s tax overhaul proposal helping to send the S&P 500 to new highs.
- Inflation disappointed again in August, but some states are beginning to display meaningful wage acceleration, as we noted in our Quarterly State Forecast this week, which bodes well for the inflation outlook.
- Next week, investors should look for hurricane impacts to inject volatility into September’s U.S. data. As a result, auto sales should see a boost while net exports should experience a drag.
Equities Soar on Trump’s Tax Reform Proposal
Investors paid close attention to developments from the White House this week, with President Trump’s tax overhaul proposal sending the S&P 500 to another record high at the end of the week. Exchange and fixed-income markets were also impacted, with the greenback appreciating and the ten-year yield rising to its highest level in two months. The proposal contains a sharp reduction in the corporate tax rate to 20% (from 39.1% currently), in addition to the consolidation of personal income tax brackets from seven to three. But the Devil is in the details, of which the plan was largely barren. If delays or opposition to the proposal prevail, equities could pare their gains on diminished expectations for future earnings.
Meanwhile, on the economic data front, Friday’s PCE report marked another month of decelerating inflation in August (Chart 1). Consumer spending was also weak, but that is partly attributable to Hurricane Harvey’s disruption. The report disappointed markets, but not by enough to reverse the equity gains accrued as a result of President Trump’s tax plan announcement earlier in the week.
Fixed income markets were also impacted by Fed Chair Janet Yellen’s speech on Tuesday that reiterated her view that growth prospects should support an advance in inflation in the near future. Outgoing Fed Vice Chairman, Stanley Fischer, on the other hand, injected more caution into his remarks made on Thursday in London by stating that he would like to see solid proof of inflationary pressures mounting before proceeding with tightening.
Across the Atlantic, the Euro Area is also grappling with missing inflation coinciding with solid economic growth. Underlying inflation in September remains subdued, reinforcing the ECB’s stance of cautiously tightening monetary policy. The first steps in winding down asset purchases are expected to begin next year, with further details anticipated following the ECB’s October meeting. Consumer and business confidence indicators have recently returned to pre-recession levels and investors have taken notice, with both the DAX and the FTSE ascending this week while German and UK government bond yields rose.
Next week, investors should look for hurricane impacts to inject volatility into September’s U.S. data. Specifically, auto sales should see a boost while net exports should experience a drag. This volatility should fade as rebuilding begins in the fourth quarter. While the Fed will look past hurricane disruptions in the data, inflation data will remain central in guiding monetary policy. We still expect a rate hike in December, assuming that price pressures will have had enough time to accumulate over the remainder of the year. Some regions are already beginning to display meaningful wage acceleration on account of tightening labor markets, as we noted in our Quarterly State Forecast this week, which bodes well for the inflation outlook. For example, in both New Jersey and Florida, wage growth this year is running at above 3% year-on-year (Chart 2). This strength should translate into firmer price pressures in the coming months as the increase in producer costs is absorbed by consumers.
Katherine Judge, Economic Analyst
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