Market Commentary – October

Wall Street’s Cheerful Mood Continues

Equity markets continued their winning streak this week, while volatility remains low. Perhaps not surprisingly, businesses and consumers are cheerful too. The latest regional Fed manufacturing surveys – the Empire and the Philly Fed indices – both showed a better-than-expected uptick in October (Chart 1). These readings came after the Michigan Sentiment index, a measure of consumer confidence, reached a new post-recession high last Friday.

Even the one blemish in the economic data this week was pretty small. Housing starts fell further than markets expected in September, but were heavily affected by hurricane disruptions. Permits for single family homes increased, which suggests that the weakness in starts should prove temporary. This notion is further supported by an improvement in homebuilder confidence in October. Conditions in existing home markets also remain tight, further building the case for stronger starts ahead.

The first estimate of real GDP growth for Q3 is released next week. We are tracking growth of around 2 ½%, slightly better than in our recent forecast. That pace will likely be boosted by inventory restocking and net-trade. Growth in final domestic demand is expected to be more modest at 1.6%, reflecting the temporary disruptions from the hurricanes. Domestic demand is expected to rebound 3% in Q4 as rebuilding efforts get underway.

Meanwhile, speculation is rife on who will be the next Fed Chair. Yellen, whose term expires in February, had a meeting at the White house this week. Trump has also met with noted Stanford Professor John Taylor, of the eponymous “Taylor Rule.” Also in the running are former Fed governor Kevin Warsh, and current Fed governor, Jerome Powell. Right now online markets show Powell as the odds-on favorite. He is perceived as being least disruptive to markets, while still enabling the President to be seen to put his stamp on the Fed. Taylor and Warsh would represent a bigger change, and are perceived as more hawkish choices, as both likely would have set rates higher than they are now, if they had been Fed Chair.
Many in the GOP have been critical of the Fed, which suggests an outsider like Warsh or Taylor may have a leg up. But, President Trump also has a stated preference for low rates, which may have him lean toward the status quo. Notably, selecting a new Fed Chair would break with 40 years of convention of incoming presidents reappointing Fed Chairs, even if they were appointed by the opposing party. Trump’s choice is likely to be named in two weeks.

Elsewhere on Capitol Hill, Republican’s tax reform efforts passed another milestone this week as the Senate passed its budget resolution. The resolution does not settle the specifics of tax reform, but, it does earmark $1.5 trillion for tax cuts. The work of containing tax cuts to that amount from an estimated price tag of around $2.4 trillion will be done by the tax legislation writing committees in the House and the Senate. While details are scarce, the Senate budget gets back to balance through very steep spending cuts (Chart 2). This could exert a meaningful drag on growth, potentially offsetting any near-term boost from tax reform.

Leslie Preston, Senior Economist | 416-983-7053

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