Economist's Insights

Quarterly Recap: 1Q17 Brings Surprises, Markets Remain Calm

Apr 12, 2017

The U.S. economy continued to churn along in the 1st quarter, albeit with several surprise developments. The primary surprise of 1Q17 was another 25 bps rate hike by the FOMC.  The March hike marked the first time in 11 years that the Fed felt comfortable enough with the U.S. economy to hike rates twice within a three-month period.  Coming into the year, the markets were expecting two rate hikes in all of 2017, projecting one hike in June and one in the fourth quarter.  The FOMC was projecting three hikes.  After a run of strong labor data, the Fed began communicating the likelihood of a March hike only a few weeks in advance of its March 15 meeting.  This gave investors some pause, fearful that it was a precursor to a more aggressive forward rate path.  However, the FOMC reaffirmed its existing position that it expects to hike only three times in 2017 despite delivering an earlier-than-expected hike.

As for the economic data, the labor market continued to post surprisingly strong reports. Initial jobless claims fell to their lowest levels since 1973 while January and February saw 238k and 235k nonfarm payrolls created, respectively.  However, wage growth was not as strong as expected coming into 2017 despite 19 states raising their minimum wages in January.  Equally surprising, actual consumption data was much weaker than expected.  January and February saw the first back-to-back monthly declines in real spending since 2009.  Nonetheless, sentiment remains very strong for consumers, manufacturers, purchase managers, small businesses, and homebuilders (almost every sentiment index reached cycle highs during 1Q).  Also a positive development, the data out of the Eurozone improved in 1Q despite the uncertainty surrounding Brexit, and the three general elections taking place this year in key countries.

Due largely to the stability in the economic data, the markets remained calm in 1Q despite the unexpected rate hike. U.S. interest rates were effectively unchanged with a small flattening of the yield curve.  The 10-year Treasury yield fell 5 basis points during the quarter to close at 2.40% while the 2-year yield rose 7 basis points to close at 1.27%.  The short-end of the curve was pressured higher by the FOMC rate hike.  Despite the FOMC’s assertiveness, the U.S. Dollar ended the quarter down 1.8%, a fact that is likely to be seen as positive by monetary policymakers.  Stocks were undeterred by the hike with the Dow rising 4.6%.

Going forward, there remains quite a bit of uncertainty about the future of fiscal policy. While newly elected President Trump has used executive actions to roll back some regulations, his first attempt at reforming healthcare proved that Republicans are not unified on the correct path forward.  This has raised concern among investors that President Trump’s entire economic agenda, what has been largely responsible for the recent run for stock prices, could be in jeopardy.  The optimism surrounding tax reform, fewer regulations, and a possible infrastructure investment program have all been tempered.  President Trump’s political success will be key to market performance over the coming quarters.