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

The U.S. economic calendar this week includes a look at the housing market with starts and existing home sales. Both measures were down in July, hampered by rising prices and lack of inventory. The housing market index, in contrast, rose in August. The September reading is scheduled for Monday. Also scheduled this week are August leading indicators and September flash manufacturing conditions.

Supported by the August consumer price index (CPI) report, talk of rising inflation pressures is beginning to spread. To be sure, one month is not conclusive, and the August increase was neither particularly sharp nor necessarily driven by other than temporary influences. Nor was it confirmed by the core rate. Nevertheless, breakeven rates on Tips continued to climb last week, as they have since bottoming in June. The rate on the ten-year closed at 186 basis points on Friday, the highest level since May. Not coincidentally, the price of oil has been a major factor. WTI crude oil also bottomed in June and has climbed $7 a barrel since to end last week at $49.89. And just days after Fed Governor Brainard warned that inflation expectations had declined, Friday’s consumer sentiment index from the University of Michigan showed inflation expectations rising.  

But the outlook for the economy in the third and fourth quarter is unclear. No doubt the hurricanes will have an impact, but to what degree remains to be seen. The Atlanta Fed lowered its forecast for third quarter GDP on Friday from 3.0 percent to 2.2 percent. However, they cited disappointing retail sales and industrial production reports last week as the primary reasons, not the impact of hurricanes. The New York Fed’s model is forecasting just 1.3 percent growth in Q3. The message last week from markets was less ambiguous, however. Higher stock prices, bond yields, dollar and commodities all suggest that the economy is doing just fine.

Important Disclosures:
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. Changes in CPI are used to assess price changes associated with the cost of living.
The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.
University of Michigan Consumer Sentiment Survey is a rotating panel survey based on a nationally representative sample that gives each household in the coterminous U.S. an equal probability of being selected. Interviews are conducted throughout the month by telephone. The minimum monthly change required for significance at the 95% level in the Sentiment Index is 4.8 points; for Current and Expectations Index the minimum is 6.0 points.
Indexes are unmanaged and are not available for direct investment.
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