Economic trends

Economy

The U.S. economy continues to grow at a modest pace. However, weakness in foreign economies, rising government debt levels, and a strong dollar are acting as headwinds. Looking forward, we expect the expansion to continue, but with a growth rate below the norm. Accordingly, our central bank may be able to raise interest rates, but we expect a gradual pace of rate normalization. 

Inflation

Inflation has been hovering around 1% after spending much of 2015 close to zero. The increase is driven by the strength in prices for medical care, services and housing. Looking forward, we expect inflation to rise given aggressive stimulus policies, a strong employment market and the rebound in commodity prices. 

U.S. dollar

The U.S. dollar remains strong due to the relative strength of our economy and expectations for an eventual rate hike by the Federal Reserve. In the coming months we expect the dollar to remain elevated as our currency should remain a safe haven. 

Asset class

Cash and money market instruments

Despite a modest pickup in economic activity recently, the Federal Reserve continues to hold its short-term interest rate benchmark steady. Now faced with the added pressure of maintaining global financial and economic stability, the hurdle to further tightening monetary policy has become even more difficult. For now, the Fed maintained the possibility of two further hikes in 2016 but signaled slower increases in coming years.

Intermediate government and credit bonds

Normalizing inflation amid the recovery in oil prices, and the possibility of further tightening from the Federal Reserve, should put upward pressure on yields, but ongoing monetary policy support elsewhere in the world is likely to counter those influences. Investment grade corporate bonds remain our preferred sector. Valuations and fundamentals remain stable despite increasing noise from monetary policies, economic risks and geopolitical concerns. 

Tax-exempt municipal bonds

The supply/demand imbalance continues to be the dominant theme in the municipal bond market. The good news is that investor demand is running strong. Unfortunately bond issuance by state and local governments, either to fund new projects or to refinance existing debt is falling far short of what’s needed to meet demand. Select state and local general obligation bonds as well as essential service revenue bonds remain our top sector choices.

U.S. equity 

The stock market has recovered from the decline that began at the outset of the year. Stabilization in China’s economy, increased stimulus in Europe and Japan, a rebound in oil prices and a falling dollar helped to boost equity prices. Looking forward, we expect the stock market to move higher, driven by a continuation of the economic expansion and a rebound in corporate earnings growth. However, volatility is expected to remain elevated as we approach the presidential election and work through this period of modest global growth.  

International equity

In response to difficulties in their attempts to generate an enduring economic expansion, foreign governments continue to utilize a myriad of strategies, including aggressive monetary policies. Given the strong actions by these governments and attractive valuations, international stocks are compelling from a long-term perspective. However, in the short-term we expect these markets to remain volatile given the rising political discord in many countries, a lack of consistent economic growth and excessive debt levels. 

Commodity 

After declining dramatically in recent years, commodity prices have rebounded from their lows. Oil markets have been particularly volatile, but reduced supply growth has led to a substantial rebound in prices. Looking forward, the trajectory of prices will primarily be determined by the extent of production cuts in the coming months and the success of foreign governments in boosting their economic growth rates. As the process develops, we expect significant levels of volatility. 

Potential threats

Risks and notable items to watch

Policy risks

Globally, the fiscal policy response to low growth rates has been debt financed growth initiatives, but there has been little restructuring designed to provide broad based support. As a result, monetary policy has been the de facto solution. The combination of aggressive monetary policies and rising debt increase the risk of an economic shock. 

China

Growth in China has slowed as the country attempts to shift its growth driver from debt-financed investment, such as infrastructure projects, to domestic consumption. The combination of reduced growth rates and high debt levels increases the risk of a hard landing for their economy. 

Geopolitical risks

Conflicts in many parts of the world have escalated with Russia’s involvement in Syria and the terror attacks in Paris. In addition, heightened tensions in the South China Sea also present some risk.

Debt related issues

Sovereign debt levels continue to grow throughout much of the world generating conditions associated with low rates of economic growth. In addition, high yield and emerging market debt have shown some signs of stress providing evidence that the credit cycle is maturing. 

Deflation

There are persistent deflationary forces in the current environment. Low commodity prices, high debt levels, a transition in the structure of China’s economy and divergent monetary policy between the U.S. and most other countries have resulted in low economic growth rates and rising economic imbalances.  

Cyber security

Cyber security is becoming a significant issue given persistent attacks on the international money transfer system, SWIFT, and on systemically important financial institutions.