It takes more than the threat of a government shutdown to derail the S&P 500
Quote of the week
As a matter of fact, the wheels have stopped.
What's good is bad, what's bad is good
You'll find out when you reach the top.”
-Bob Dylan, “Idiot Wind”
The Lead Story: The ECB says, “Enough already!”
What can the ECB do to stem the common currency’s increase? For starters, it can jawbone. Indeed, during the week ECB official Ewald Nowotny said the euro’s recent strength against the U.S. dollar “is not helpful.” Adding to the dovish rhetoric, Vitor Constancio, the ECB’s second in command (behind President Mario Draghi), opined that sudden movements in the exchange rate “don’t reflect changes in fundamentals.”
While the ECB may be fretting the euro’s move, dollar-based investors certainly are not. Europe’s broad STOXX 600 Index rose 0.52% in local terms for the week but a far better 1.33% in U.S. dollars, the STOXX 600’s fifth consecutive week of 1%+ returns in dollars. For the year to date, the index has advanced 2.92% and 4.71% in local and dollar terms, respectively.
In other news: Why not trust the Fed?
As of January 19, the market has priced in about 2½ Fed rate hikes this year, while the Fed anticipates three. In 2019, traders expect just one hike, compared to 2-3 for the Fed. While we’re somewhat puzzled by this discrepancy, we think it’s because traders are not quite as optimistic as the Fed regarding U.S. economic growth and inflation.
In our view, inflation should begin to accelerate, driven by a number of factors: a tightening labor market, with first-time jobless claims hitting a 45-year low; fiscal stimulus through tax cuts; and reduced slack in the U.S. economy, as reflected by December’s pickup in capacity utilization. (Capacity utilization finished the year by rising a better-than-expected 77.9%. While this is still below pre-recession levels, a move above 80% could signal rising production costs and prices are on the way.)
Below the fold: Upbeat news for U.S. manufacturing counters lower homebuilder and consumer optimism.
The Back Page: Equity markets may ignore a government shutdown
Since 1976, the U.S. government has shut down 18 times. The last one occurred in October 2013, when U.S. stocks fell a cumulative 4% before fully recovering within 10 days of hitting their trough. As shutdowns go, that one stirred up considerable volatility: on average, government closures have lasted seven days, during which time U.S. equity markets have fallen a mere 0.6%, on average.
As of late Friday afternoon, no agreement had been reached on Capitol Hill to continue funding the government beyond midnight on January 19. Given the market’s extraordinary ability to shrug off natural disasters, geopolitical concerns, and terrorist attacks, perhaps it comes as no surprise that U.S. stocks have continued to rally. Overall, we don’t expect this round of political brinksmanship to affect equities significantly.
This impact, while small, would add to relatively minor economic challenges percolating in the first quarter—the largest of which is the increase in commodity prices, which has led to higher gasoline and home heating costs. Nonetheless, we believe these headwinds will be superseded by tailwinds created by tax cuts and ad hoc corporate bonuses, triggering an uptick in consumption in the first half of this year.