What To Expect From The Financial Markets
Over the past two days, investors have been given a hearty serving of
positive economic data, confirming the view that the US economy should continue
on an uptrend while inflation will likely remain subdued for the time being.
Yesterday’s stronger than expected 3.1% GDP growth for the second quarter was
important for three reasons:
1)Â Â Â Â Growth was quite robust across all sectors of the
economy including:
a)Â On the consumer level (which many observers keep believing will lose
its luster but hasn’t)
b)Â On the business level (which showed the biggest increase in spending
since 2000)
c)Â On the government level (which admittedly was expected)
2)Â Â Â Â Inventory data was lower than originally expected,
which detracted from overall GDP growth–remember, inventories are included in
GDP. However, this is a positive development for two reasons. First, it means
that the pickup in business sector is coming from increased demand (good for
earnings) and not inventory restocking. And second, it means that businesses
will have to rebuild their inventories in the quarters ahead and thereby
contribute to further growth.
3)Â Â Â Â Â Inflation, as measured by the GDP price
deflator, remains quite subdued. In fact, for the second quarter, inflation grew
by a wimpy .9% annualized rate, which caught many people by surprise–especially
in the bond markets. As I discussed in my column on August 25, capacity
utilization is at historically low levels and should keep prices in the economy
from rising too quickly. In my view, the interest rate markets have been too
aggressive with their expectations for inflation and therefore tighter monetary
policy. But as we receive benign inflation data, such as yesterday’s deflator
number, the aggressive selling in bonds will ease up.
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In my view, the equity markets should continue their steady climb, as the
pickup in business spending will now contribute to top line (revenue) growth,
while the bond markets will likely take a breather over the next couple of weeks
before moving higher. The10 year yield should remain below 4.6% and
then assume a more orderly climb to the 4.75% – 5% level by year end. Fed funds
futures should decrease their expectations for a quick change in monetary
policy. Benign inflation data should depress gold in the short term, before
moving higher later this year.