The US economy grew at an annual rate of 2.5% in Q4 2017, 0.1% below Q3 (Q3 revised down from 3.3% to 2.6%), yet, it repositioned itself back within the 2-3% normal growth and away from recessionary risk. The decline in GDP reflects, partially, the gradual acceleration in PCE from 0.1% in September 2017 to 0.2% by year’s end. The PCE price index increased 2.7%, compared with an increase of 1.5%, but note, real GDP in 2017 increased 2.3% compared with an increase of 1.5% in 2016, while inflation is low, but increasing. With the economy improving moderately and changes in fiscal policy evidently spurring profitable business growth it was eminent that the Fed would raise the interest rates three times in 2018 to thwart inflation, an implementation of contractionary monetary policy that decreases money supply. From one perspective fiscal policy boosted business growth and we saw equities stimulating a bullish uptrend, from another, the most recent fiscal changes in tariffs led to a correction not seen in two years on concerns over a global “trade war” - markets anticipate the first rate hike to take place in March -. Note that most analysts believe the correction was caused by concerns over raising inflation at the time when new Fed Chair Powell signaled that four rates could be possible this year instead of three as no signs of a recession are seen despite the tight job market (4% unemployment) and the surprising increase in wages. Fears of higher Inflation were indeed turning the markets jittery but did not cause February’s correction.
The price fluctuations caused not only in February but also as a result of the sophisticated fiscal and monetary policy changes, no matter the underlying reasons, affected, markedly, the market’s volatility. According to Fed Chair volatility will not stop hikes as wage growth and higher producer prices signal firming inflation, however, more hikes present a bigger risk than volatility itself.
Rising interest rates have a negative effect on national debt and what the government has to pay to bondholders. With the 10-Yr Treasury Yields nearing 3%, growing foreign and domestic investment could become muted. And when considering the continuously increase in wages and the shortage in the US labor market, the risks of recessionary periods becomes greater despite a strong growth performance. Hence, productivity growth in a tight labor market is very critical to counterbalance the risk of a recession rise.