Fed Hike, Fiscal Tailwinds, and Trade War
Last week, the Fed hiked interest rates by 25 bps. This was widely expected, but the hawkish tone surprised the market. The Fed officials’ projections now suggest three hikes in 2019 as well, and Chairman Powell highlighted that the economic outlook has strengthened.
This is the first rate hike of 2018, and, with the data recently showing an acceleration in the pace of inflation, the Fed is set to continue a gradual tightening of policy. Monetary conditions are beginning to shift, and, in response, corporate bond yields and mortgage rates are rising.
Federal Funds Target Rate
Source: Thomson Reuters Datastream, as of 3/23/18. Past performance is no guarantee of future results, which will vary.
While higher rates can be restrictive to growth as they increase borrowing costs, the impact of tailwinds from tax reform and increased federal spending is expected to be almost four times as large as the headwinds from the recent tightening in financial conditions.
Another major development was the announcement to impose 25% tariffs, affecting about 60 billion dollars of imports from China. The focus will be on IT, aerospace, and machinery sectors. In response, the Chinese Commerce Ministry announced planned tariffs targeting three billion dollars in U.S. goods, with focus on food products and steel pipes.
In itself, these tariff measures are unlikely to have a major impact on the economy, as the tariffs affect less than 3% of total U.S. goods imports. Still, retaliation and escalation into a wider trade war is a risk we are monitoring! Sectors like technology and agriculture in the U.S., which are more reliant on trade with China, could be impacted more than the others, and investors should be mindful of these exposures in their portfolios.
Trade with China (2017)
Source: Census Bureau, as of 3/23/18.
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