In contrast to the growth dynamics of the past three years, the US economy is on track to expand by +2.4% in real terms in the first quarter. Stronger-than-expected data released in February is supporting equity values, whereas bond yields have barely moved. When looking at the current rise in stock markets, the impact of cyclical expansion on profit growth is probably as important as the expected tax cuts and regulatory easing. In addition, investor flows and positioning have now turned bullish, but not exuberant – and certainly not irrational – given the fundamental improvements achieved over the past twelve months.
Robust US data continue to be the performance engine for risk assets. Ever more economic releases surprising on the upside (NFIB small business optimism, Philly Fed, Conference Board leading indicator, and retail sales, among others) are positive surprises in and of themselves. It is reassuring to see this newsflow at the current juncture as the first quarter has traditionally been particularly weak in previous years (0.9% on average since 2003). The US economy should expand by 2.4% in Q1 2017, according to the Atlanta Fed GDP Now forecast. In addition to the US, the economic recoveries in Japan and Europe appear to be broadening further, as seen in the flash PMIs and the IFO index for the month of February.
Risk assets advance as they price in stronger growth and US corporate tax cuts. The momentum of upward surprises in US economic newsflow has accelerated since Q4 2016, sustaining the rise in equity values. We take note of these developments but we know that the former series is mean reverting and that the recent increases will be hard to sustain over the coming months.
Treasury bond yields have barely moved since mid-December, possibly due to accommodative central banks (in particular the interest rate pegs in Japan and Europe) and the inertia of inflation expectations. A contained rise in bond yields favors the extension of rising equities but signals increased caution on rising political risk.