In this Issue:

Volatility Returns to Financial Markets, but US Economic Fundamentals Remain Solid

The opening months of 2018 have seen volatility return to global financial markets, but we think it is important to stress US economic fundamentals have remained broadly the same. After an unusually long period of calm in many markets, the reappearance of volatility at some point seemed likely, even if the speed of market gyrations has been unsettling for investors. We see this year’s rise in US Treasury yields as a healthy development, since for some time long-term interest rates have appeared too low, relative to the strength of activity in the US economy and globally. We also believe the outlook for the US economy remains constructive, with little evidence of overheating as yet. However, any extended bouts of market volatility may represent an additional factor for the US Federal Reserve (Fed) to take into account, as it decides how quickly to further tighten monetary policy.

Stronger Global Economy Changes Market Sentiment on Inflation and Interest Rates

It is difficult to assess when corrections in financial markets become sufficiently extreme to begin affecting economic activity. But at this point we do not foresee any significant impact on the global economy from the recent market turbulence. We view it instead as a healthy tempering of excessive optimism among equity investors. Just as the likely consequences of the cyclical upturn in global growth—a gradual return to more normal levels of inflation and interest rates—had, to some extent, been overlooked in market pricing, they now risk being exaggerated. Assuming the effects of the market volatility, on both the confidence of consumers and the assuredness of central bank policies, are relatively muted, the shift in financial markets to levels that better reflect the state of the global economy appears to us to be a welcome development.

Eurozone’s Subdued Inflation Likely More Important than Robust Growth in ECB’s Calculations

Growth indicators in the eurozone continued to indicate a robust pace of expansion, though there has been little sign of inflation emerging, as the strength of the euro has shielded the region from higher energy costs. The strength of economic activity has boosted speculation that the European Central Bank (ECB) will float a change in monetary policy at its next meeting in March, with some hawks urging the adoption of a less accommodative approach. We think such an announcement is more likely later in the year, as ECB President Mario Draghi could be reluctant to reduce his options so soon, given the region’s still subdued inflationary pressures, as well as the unpredictable outcome of the Brexit negotiations.



Volatility Returns to Financial Markets, but US Economic Fundamentals Remain Solid

The opening months of 2018 have seen volatility return to global financial markets, but we think it is important to stress US economic fundamentals have remained broadly the same. After an unusually long period of calm in many markets, the reappearance of volatility at some point seemed likely, even if the speed of market gyrations has been unsettling for investors. We see this year’s rise in US Treasury yields as a healthy development since for some time long-term interest rates have appeared too low, relative to the strength of activity in the US economy and globally.

We also believe the outlook for the US economy remains constructive, with little evidence of overheating as yet. Recent data have generally supported the positive domestic backdrop, and many growth forecasts have moved up to reflect the potential effects of the recent package of tax cuts. However, any extended bouts of market volatility—and the possible dampening effects on consumer sentiment—may represent an additional factor for the Fed to take into account, as it decides how quickly to further tighten monetary policy.