Will Janet now start to worry Goldilocks porridge is a bit hot for her liking

Global equities have started October from where they left off last month boosted by some strong Manufacturing Purchasing Managers Surveys for the month of September. Buy volumes were robust suggesting that money managers wanted to put money to work for the final quarter. Institute for Supply Manager surveys are released at the start of every month and an index reading is produced based on managers responses to new orders, inventories and employment. As we have stated on more than one occasion an index reading above 50 suggests economic expansion, below 50 contraction.

On Monday the US recorded a manufacturing reading above 60, the first time since 2004. Writing this piece over the years we often used to quote the phrase “bad economic news is good news for stock prices”. The predication of this view, held by many, was that bad economic news would encourage central bankers to introduce further stimulus measures to support the global economy. The so-called central bank put. More recently we moved into the Goldilocks period, modest economic growth, limited inflationary pressures, improving company earnings and central bank monetary policy remained supportive for risk assets. 
This recent strength in the US economy could receive another boost if Donald Trump manages to introduce his tax reforms. This should be all good to continue to drive equity prices higher.

Will this increased strength in the economy be further boosted by tax changes rush the Fed into moving rates faster than expected? We have from time to time in the past years seen moves in the bond market and once again yields are starting to tick higher. Higher bond yields offer a mixed message, on the one hand, it should demonstrate an improving economic outlook, on the other, it makes equity prices less attractive. The US two-year treasury now yields 1.49%, this is the maturity that is considered the most sensitive to changes in interest rate sentiment. 

Economists talk of policy mistakes that lead to sharp moves in bond and equity prices. Jean Claude Trichet was considered to make one in 2011 as the ECB raised rates just as the global economy was trying to recover. It could be argued that Mark Carney made one last year, and is now probably going to make another one in November. 

The Federal Reserve has introduced the idea of forward guidance to prepare the markets in advance of any rate rises. An FT report a few weeks ago pointed out that 10 of the last 13 Fed tightening cycles have resulted in an economic recession. We shall see what the Fed will do next. Later on, Wednesday Janet Yellen speaks at a community banking conference, will her forward guidance suggest Goldilocks porridge is no longer just right but a tad on the warm side. 

Posted on October 3, 2017 .