Current Thinking

Financial Markets and the Economy: 5 Things to Look for in 2017

A blog by Frederic Slade, CFA, Assistant Vice President and Senior Director, Investments, Pentegra Retirement Services – January 17, 2017

When projecting what the main drivers of the capital markets and the world economies will be in the upcoming year, I am reminded of the saying, “expect the unexpected.” Nonetheless, I put forward five areas that could have a significant impact in 2017:

Monetary vs Fiscal Policy
Over the past decade, the Federal Reserve’s monetary policy actions have generally overshadowed fiscal policy (government spending and taxes) as an economic policy tool. This may be changing under the new administration, which has called for significant spending on infrastructure, such as bridges, roads and tunnels. Large tax cuts for corporations and individuals are also being proposed. While the Federal Reserve has generally charted a low interest rate, moderate growth environment, 2017 may portend faster growth, with higher inflation and higher interest rates as fiscal policy assumes a larger role.

Deregulation
The coming year is likely to see significant easing and/or elimination of regulations in the United States financial industry. This includes restructuring Dodd-Frank, eliminating the Volcker Rule, reducing regulatory requirements for banks with favorable examination records and possibly postponing or amending new fiduciary rules for investment advisors. To the extent deregulation moves forward in 2017, banks may consider loosening lending standards while still maintaining strong capital bases.

Interest Rates
There has been a big shift in the interest rate environment in 2016 that is expected to extend to 2017. The yield on the 10 year United States Treasury Note has risen 70 basis points since the end of October. The Federal Reserve raised short term interest rates in December and is expected to raise rates several times in 2017. Given the momentum toward higher rates, what might slow down (or even reverse) this rise in interest rates? First, growth in the United States economy and inflation may be slower than expected due to factors such as higher mortgage rates, low productivity and reduced earnings from exports. Second, the attractiveness of United States Treasury yields may attract foreign buyers, thus pushing interest rates back down.

Currency and Trade
Several items are likely to be front and center in 2017: the strong dollar; potential restructuring of free trade agreements (such as NAFTA1) with international partners; and possible tariffs on goods imported into the United States. The strong dollar is likely to contribute to the United States trade deficit and to slow growth. Trade policy may help keep additional manufacturing jobs in the United States but also raise prices of domestic and foreign goods.

China
China’s economy and capital markets have been impacted by a number of events, including: (a) flight of capital from the country, estimated at $1 trillion in 20162; (b) a declining currency (the yuan); and (c) attempts by the Chinese government to support the yuan, which have been largely unsuccessful. Despite these problems, China remains a significant player in the world markets with a current 6.7% growth rate in Gross Domestic Product, and has historically been one of the top buyers and sellers of United States Treasuries.
It will be interesting to see how the above five factors play out in 2017.

1. The NAFTA agreement established a free trade zone in North America and was signed in 1992 by Canada, Mexico and the United States.
2. Christopher Balding, “The Fed Puts China in a Bind”, Bloomberg View, December 20, 2016.

NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.