Will Trump’s fiscal stimulus lead to inflation?

Without a surge in monetary growth, fiscal policy alone doesn’t indicate inflation

John GreenwoodFinancial markets have reacted strongly to the election of US President Donald Trump. While equities in the US and elsewhere have risen strongly (reflecting expectations of stronger growth and therefore improved corporate earnings), bond prices have fallen (reflecting higher yields, in turn a result of higher inflation expectations). As debate continues around President Trump’s fiscal stimulus program, a key question has emerged: What role might his policies play in creating inflation?

A large fiscal deficit does not necessarily lead to inflation

Among the main drivers of higher inflation expectations, one is

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Fourth-quarter 2016 earnings largely positive for large-cap growth companies

Investments in R&D lay the groundwork for potential future growth

JohnFrank_smAs fourth-quarter earnings season winds down, it appears that US large-cap companies are on solid footing. Average year-over-year earnings for the S&P 500 Index grew two consecutive quarters to close out 2016 — the first time that has happened in more than two years.1

Large-cap growth companies fared especially well during the fourth quarter, with the Nasdaq-100 Index recording its third consecutive quarter of year-over-year earnings growth. Both the Nasdaq-100 Index and the S&P 500 Index exceeded Wall Street earnings expectations in the fourth quarter — beating average consensus estimates by 7.1% and 2.6%, respectively.1

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Fed hikes short-term rates for third time in 15 months

Fed’s constructive growth and inflation outlook likely paves the way for further hikes

CorumJames OngThe US Federal Reserve (the Fed) hiked its benchmark short-term interest rate by 25 basis points today, as expected. The statement was generally neutral, in our view, with upbeat commentary around the current growth backdrop. Inflation commentary was more mixed, stating that headline inflation has moved closer to the Fed’s target, yet emphasizing that core inflation continues to run below the Fed‘s target. Overall, the statement was similar to the January‒February statement, meaning that little has changed to alter the Fed’s view since then.

The Fed also released its widely anticipated Summary of Economic Projections (SEP), which includes the forecast of the federal funds rate or the so-called “dots.” The projected year-end 2017 federal funds rate indicates three rate hikes, unchanged from December’s SEP release, while the bond market had only been pricing in two prior to today’s announcement.1 The longer-run federal funds rate was unchanged at 3.0%. Growth and inflation projections were largely unchanged with only a slight upward revision to 2017 core inflation, from 1.8% to 1.9%.2

In her press conference, Fed Chair Janet Yellen stated that an unchanged SEP is consistent with gradual rate increases over time. The Fed is discussing and monitoring fiscal policy changes but has not yet included potential impacts in its projections. Therefore, federal funds rate projections were left unchanged.

Looking ahead

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Fed hikes short-term rates, citing expanding economic activity

Rate hike is third in 15 months, two more likely in 2017

Bloom Jason_sm_150dpi_RGBThe Federal Reserve raised interest rates today by 0.25% — the third such rate hike in the past 15 months. The Fed’s decision was largely priced into the financial markets, which assigned a 98% probability to the rate increase in the days leading up to today’s announcement.1 In keeping with its two previous rate hikes, the Fed explained today’s decision as an appropriate response to an economy expanding at a moderate pace and a labor market experiencing solid jobs gains.

Rate hike seems unlikely to derail US economic growth

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India’s economy: What does 2017 hold in store?

Driven by demonetization, India’s economic rejuvenation points toward a positive long-term outlook

Sambhshivan_Shekhar_sm_150dpi_RGBBy any measure, 2016 was a year of seismic economic change for India, particularly with the surprise “currency exchange program” in November, also referred to as demonetization. Three months after this unprecedented move, the overhang already seems to be behind us. Industrial production surged sharply by 5.6%, capital goods within manufacturing recorded 15% growth after several months of contraction, and electricity generation picked up to 8.9%.1 Overall car sales also reported an increase of 16% year-over-year.2 These positive macro points confirmed the view of the Equity Investment Team in Asia that the impact of demonetization would be transitory in nature.

Structural growth in India — especially domestic consumption — remains promising over the long term. Looking ahead, we expect

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Fed rate hike: Further monetary tightening expected amid synchronized global growth

Bond markets likely to absorb rate increase with limited impact, but questions remain on Fed’s economic projections

James OngCorumIn its March 14‒15 meetings, the Federal Reserve (Fed) will decide whether to raise interest rates for the third time since it began monetary policy normalization 15 months ago.1 Invesco Fixed Income believes there is a high probability that the Fed will raise its policy rate by 0.25% next week. Fed Chair Janet Yellen and Vice Chair Stanley Fischer have indeed signaled in recent statements that they believe a rate increase is likely to be appropriate. Further monetary tightening has been in the cards for some time; however, the bond markets had not placed a high probability of a March rate hike even a few weeks ago.

What has changed in the last few weeks to cement expectations of a March hike?

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‘Buy the rumor, sell the fact?’ Not in today’s world

Recent events have shown that a strong economic backdrop trumps near-term turmoil

There’s an old adage on Wall Street: “Buy the rumor, sell the fact.” This conveys the idea that markets tend to rise on expectations of a positive event and sell off after the event occurs. In other words, because market expectations often go too far, sentiment can cool quickly once an event actually occurs and investors move on to the next big thing.

Two watershed events turn an old adage upside down

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Aerospace and defense: Investment opportunities are on the radar

A potential increase in defense spending and an uptick in commercial aircraft orders could boost the industry’s prospects

Nick KalivasThe defense industry has been a strong performer since the Nov. 8 US elections. Between Nov. 8, 2016, and Feb. 24, 2017, the SPADE Defense Index has rallied 14.54% — outpacing the S&P 500 Index by more than 3%.1 Given the scale of the Trump administration’s proposed defense budget, as well as positive trends in commercial airline orders, I believe prospects are favorable for aerospace and defense firms.

US aerospace and defense orders are rising

After showing flat to declining growth since 2010, US defense orders — which include aircraft, related parts and other military hardware produced by the Department of Defense — have been trending upward and are now approaching

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China: Making solid progress on its Five-Year Plan

As the National People’s Congress convenes, we highlight three government priorities to watch

Mike_ShiaoThe annual National People’s Congress (NPC) started on March 5, 2017, with Premier Li Keqiang announcing key economic growth targets and major reform initiatives designed to help China achieve stable growth and become a “moderately prosperous” society by 2020. These announcements are in line with the vision that was laid down two years ago in China’s 13th Five-Year Plan.

China was largely on track with its policy targets in 2016. The economy grew 6.7% (as seen in the table below) while making progress in reducing industrial overcapacity and financial risks. 2017’s key economic targets are designed to build on that progress, with further fine-tuning in growth rates widely expected, to allow room for the Chinese government to proceed with reform issues such as overcapacity and leverage.

The table below compares the key targets announced this year and last year:

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History rhymes: Comparing China today with 1920s Japan

China faces two main options in dealing with its economic distortions

John GreenwoodThe Chinese currency has been depreciating since January 2014, and the balance of payments has weakened. There has been a substantial decline in the current account surplus relative to gross domestic product (GDP) since 2010 and, more recently, persistent private sector capital outflows.

The question is: How long will the Chinese yuan continue to depreciate and how much will China’s exchange reserves decline?

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