Summary and Conclusion:
Asset prices remained declined in October as a drawdown in the supply of dollars on Central Bank balance sheets, primarily in the United States and China, offset the strong earnings that reflected continued solid economic growth and the corporate tax cut. Following a bullish assessment of the economy by the FOMC at the September 26th meeting and by Chairman Powell at his speech before the National Association of Business Economists (NABE), the 10 year Treasury bond yield climbed above the 3 percent level and reached nearly 3.25 percent before falling back to 3.2 percent. The S&P500 index of U.S. equity market prices fell during October ending the month roughly 5 percent below the end September level and roughly 1.5 percent above the level of yearend 2017. For most of October, the equity market maintained the trend of steady decline in asset prices at relatively low volume and higher volatility than has characterized equity markets over the past several years, save the February – April period when assets were repricing to reflect the changes to relative after-tax earnings due to U.S. Federal tax legislation. The VIX was relatively high during the month but declined back to the levels that characterized the past several months following the completion of the mid-term elections.. The higher level of the 10 year rate, relative to that of autumn 2017, is consistent with a pickup in productivity growth based on stronger investment spending last year, as well as expectations of continued strong investment due to the incentives for investment spending in the recently passed tax bill. The 2018Q3 GDP release as well as the November 8 FOMC Press Release removed traders concerns regarding economic activity, business investment and inflation. Net sales of Treasury and Mortgage backed Securities by the Federal Reserve and some other Central Banks is also contributing to the rise in the yield on 10 year bonds. The Federal Reserve decided to raise the target range of the Federal Funds rate to a target range of 2.00 to 2.25 percent at its September 26th meeting and leave the target range unchanged at its meeting on November 8. . (The latest release on core and headline inflation based on the PCE price index registered 2.0% (headline) in September relative to September of 2017 and 2.0% on core (excluding food and energy). The Fed’s target is 2.0 percent inflation on the headline PCE price deflator. (The Fed in its November Press Release again emphasized that the 2 percent objective is a symmetric one allowing for some overshoot as well as undershoot of inflation.) The dollar appreciated roughly 1.5% against the major currencies -- a level nearly 5.0 percent stronger than its January 2018 reading, but 4.5 percent weaker than in January 2017. I attribute the stronger dollar since January 2018 to a combination of the Federal Reserve’s normalization of its balance sheet (- $320 billion) that has more than offset the increases in international reserves of foreign central banks as well as the continuation of strong U.S. growth and the risk of weaker than expected growth abroad.