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Booming Growth Blindsides Central Bankers

Booming Growth Blindsides Central Bankers
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By    |   Tuesday, 23 January 2018 03:59 PM

This is a beautiful time to be an investor. The S&P 500 is up over 35% since the November 2016 election and the Dow Jones and the NASDAQ are up considerably more. The indexes seem to break new all time highs every day with no sign of stopping.

This new raging bull market isn’t based on “irrational exuberance” either. It’s backed by accelerating fundamentals. Earnings for companies on the S&P 500 averaged better than 11% growth for the last two quarters and are projected to grow at an even stronger clip in 2018.

Recent consumer and business confidence numbers are near the highest ever recorded. The economy is growing at a stronger sustained clip than it has through the whole recovery. And the global economy is stronger than it’s been in more than five years.

But here’s the thing. These facts were all true before the passage of the tax bill. The lowering of the corporate rate from 35% to 21% will clearly increase earnings even more. Of course, some expectation of the legislation was already built into stocks prices but the actual, tangible delivery will provide further upside.

Earnings estimates have since been upgraded and the IMF just increased 2018 global growth projection because of US tax reform. The recovery and the bull market got a huge second wind. And the market may still have considerable upside from here. What’s not to like?

The problem is that even good news and positive events can have negative repercussions. Everything affects something else. A negative side effect of this booming growth may involve the world’s central bankers.

Ever since the financial crisis the Fed, along with central bankers across the globe, injected massive and unprecedented stimulus to boost the slow recovery. Massive bond buying programs and near zero interest rates are still in effect in Europe and Japan. Global interest rates remain below any level in modern history.

Old habits die hard, and the Fed and other central banks are still fighting the old nemesis of slow growth and benign inflation. Our Fed doesn’t seem to believe we are headed for a stronger period of growth despite the fact that the economy has been growing at a better than 3% clip for several quarters now.

All indicators are that we will likely see 3% or perhaps 4% or better GDP growth in the months and years ahead. But the Fed doesn’t seem to believe it. Fed Chair Janet Yellen recently said the tax bill will likely add “some modest lift” to the economy and the Fed raised GDP growth estimates from 2.1% to 2.5% for 2018.

The Fed isn’t an outlier either. Many other forecasting agencies are basic predicting more anemic growth with a temporary minor lift from tax reform. The consensus elitist opinion out there is that injecting the largest tax cuts in 30 years into an already accelerating economy won’t have much effect.

This could be a big problem. The one thing the Fed seems ill equipped to deal with is strong growth. Right now, most predict the Fed will raise the Fed Funds rates three times (at 0.25% each time) in 2018. The market is fine with that because the rate would still be at around 2% at the end of the year, far below the recent historical average of about 4.5%.

The problem is that the Fed could be surprised. If we get 4% GDP growth the Fed will have to raise rates at a much faster clip than currently anticipated to prevent asset bubbles and inflation. The market doesn’t like surprises. The prospect of rapidly rising rates and inflation seems unreal because we haven’t experienced such things for so long.

The Fed and other central banks have essentially disarmed themselves against inflation and economic excesses. But such things might be just around the corner. Beware, a surprised Fed may well hasten meaningfully higher rates much sooner than most anticipate. Such an event could roil the stock and bond markets this year.

Tom Hutchinson is a Wall Street veteran with extensive investing and finance experience.

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TomHutchinson
The problem is that even good news and positive events can have negative repercussions. Everything affects something else. A negative side effect of this booming growth may involve the world’s central bankers.
booming, growth, central, bankers
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2018-59-23
Tuesday, 23 January 2018 03:59 PM
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