Strong growth and benign inflation will be positive for the US stock market in 2017. Core inflation slipped again in November.
Bond yields will still rise as the Fed belatedly unwinds the extreme monetary easing required after the financial crisis. The FOMC may announce three, even four, rate hikes and a gradual reversal of QE in 2017, ending its existing policy of reinvesting principal payments and rolling over maturing Treasury securities. That should cause the curve to steepen again between 7 and 30 years. The ten-year yield could increase to 4.0% (2018).
This may not stop the S&P 500 from hitting new highs (3,000 by 2018). QE was not the primary driving force behind the rise in US stock markets from 2009 onwards. Profits recovered quickly after the 2008 slump, climbing to a record high as a share of GDP. Skill shortages are an issue, but tax cuts and deregulation will raise capital spending next year. Huge outlays on software and R&D will also boost productivity, allowing companies to pay higher wages and protect profit margins.
Summary
- Fed may start unwind of QE in 2017
- Reversing QE/higher Treasury yields not a threat to equities
- Trump policies could accelerate investment, innovation and keep inflation low
