OLDWICK, N.J.--(BUSINESS WIRE)--Although the U.S. financial markets remain deep and liquid, A.M. Best will continue to pay close attention to the flattening yield curve and recent increase in market volatility. As short-term interest rates have increased owing to the U.S. Federal Reserve’s (Fed) recent rate hikes, longer-term yields have been slower to respond. According to a new A.M. Best report, the Treasury Department will need to issue close to USD 1 trillion in Treasuries in the coming year because of the tax reform law, and this increase in supply to the market will be compounded by the Fed’s unwinding of its quantitative easing program.
The Best’s Special Report, titled, “2018 Economic Outlook: More Left in the Tank?” notes the record highs the equity markets experienced in January; however, February has gotten off to a difficult start, with a return of market volatility and a sell-off in equities and bonds. Ten years of accommodative monetary policy, combined with the Fed’s quantitative easing, had depressed market volatility and stretched asset-price valuations, including investment grade debt, below investment grade credit, real estate and equities. As the stimulus slowly diminishes, some volatility is likely to return to markets, as risk and term premiums are re-priced. Demand remains high for these securities, and because the market has already priced in increased supply, forecast tighter monetary policy and the possibility of higher inflation, A.M. Best expects to see longer-term yields creep higher, widening spreads.
The U.S. economy accelerated in the second half of 2017, posting growth rates of 3.1% and 3.2% in the second and third quarters, respectively. The pace slowed to 2.6% in the fourth quarter, largely due to higher imports from a weaker U.S. dollar and hurricane rebuilding. Consumer sentiment in October 2017 reached highs not seen in more than 13 years, only to slide back slightly in November. However, personal household savings rates continued to fall, to 2.4% in December, the lowest since September 2005 and well off the post-financial-crisis high of 11%, calling into question the sustainability of the current consumer-driven economic expansion.
Labor markets continued to strengthen throughout 2017 even though there was not a materially stronger hourly wage growth or a measurable increase in the labor force participation rate. Nevertheless, the labor market is expected to tighten further in 2018, and wage growth will likely pick up as a result.
Tax reform should provide additional stimulus to the economy in the near term, through higher disposable incomes and corporate earnings. As the economy continues to expand, A.M. Best expects the Fed will continue on its current path to normalize monetary policy. However, higher base lending rates and tighter monetary policy will lead to increased pressure on household balance sheets as debt service costs rise. Higher debt service rates could mitigate any relief from tax reform in the coming year, depressing consumption and consumer sentiment. Also, an unexpected increase in inflation, market volatility, higher default rates, the appearance of asset bubbles owing to extended easy monetary policy or slower growth in 2019 could change the pace or direction of current interest rate policy.
To access a copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=270356.
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