Several Signs Point to Strong Economic Conditions

The S&P 500 enjoyed its best week since the first week in January, adding 1.6 percent to close at 2500 for the first time. Most of the gains came early in the week after a weekend in which North Korea refrained from another missile launch, and the destruction from Hurricane Irma, as bad as it was, was not as devastating as feared. As it turned out, North Korea was simply waiting for a different launch date, this time on Friday. But stocks held onto their gains anyway, rising fractionally on Friday to close at a new record high. Although markets took this latest provocation in stride, the North Korean threat has certainly not gone away, and will be the topic of discussion this week at the UN.

Leading the way higher were the financial stocks, which added 2.8 percent as they tracked the rebound in bond yields. The yield on the ten-year Treasury retraced the ground that it had lost over the previous month. After ending the previous week at a yield of 2.05 percent, its lowest level since the election in November, the ten-year note rebounded strongly to finish the week at 2.20 percent. Echoing the move in bond yields was the dollar, which traced a similar path after ending the previous week at a two and a half year low, as measured by the DXY dollar index. It was a solid week for the reflation trade in general, as energy, materials and industrials all outpaced the overall index. The only laggards were the rate sensitive real estate and utility sectors.

What’s Next for the Fed? 

Reinforcing the firmer tone was the August consumer price report. The trailing twelve-month headline rate rose for the second straight month to 1.9 percent, while the core rate held steady at 1.7 percent. The report contributed to the shifting view that the Fed may, indeed, raise rates once again in December, a view that had been discounted following months of frustratingly low inflation readings.

The Fed does meet this week, and it is expected to leave rates unchanged. However, it is also widely expected to announce the start of its balance sheet unwind, something for which it has taken pains to prepare the market. Nevertheless, the reality of another step in the process of policy normalization will be monitored carefully for any signs of anxiety, especially in bonds. Not to diminish the importance of such a step, but the meeting of the European Central Bank on October 26 is arguably more impactful for markets in the near term, as it is expected to announce its intentions regarding its Quantitative Easing program, which expires at year-end.

U.S. Economic Conditions Appear Solid 

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