Economic and Stock Market Commentary for the week of May 23, 2018

Inflation is back in the headlines, after years of being an afterthought. This is not to suggest the Federal Reserve now has a serious problem on its hands. In fact, the latest monthly figures on wage growth and consumer prices argue against that. Still, with inflation approaching the Fed’s 2% target, with the economy picking up steam, with new tariffs lifting import prices, and with expanding Middle East discord pushing oil prices upward, it is logical to assume that inflation and interest rates will tick higher.

Nevertheless, price increases should be modest. True, tighter labor markets, rising import prices, and higher oil quotations suggest inflation will be more of an issue going forward. That said, unless there are fiscal missteps at home or further discord abroad, there should be enough available capacity at U.S. factories for inflation to just modestly overshoot the Fed’s 2% target over the next year or two.

As noted, the economy continues to press forward, with data on retail spending, industrial output, and factory utilization all pointing to a spring heat up. That is likely to be sufficient to lift GDP—which rose by 2.3% in the first quarter—by more than 3% in the current term. Growth of 3%, or so, is likely in the second half.

Earnings season has come and gone, and it was a good one. The next several quarters should be supportive, as well.

So the focus now will shift to other areas, with the Federal Reserve’s June meeting, the recent sharp climb in yields on the 10-year Treasury note (a debt instrument that has a major bearing on mortgage rates), vexing issues with China and North Korea, and heightened tensions with Iran all likely to affect trading in the days and weeks to come. That said,

The bulls still hold the upper hand. And that may be slow to change. True, the Fed, China, North Korea, and the Middle East can affect the ebb and flow of the markets for a time. But traders usually return to the fundamentals before long. And here, with respect to the economy and earnings, the news remains generally supportive.

Conclusion: We caution, though, that even if the bulls retain the edge, that hold is likely to prove tenuous, especially if interest rates rise much further.

Source: Valueline.com