As we move deeper into the year, we see the potential for a change in the direction of the prevailing wind across global markets and economies. Why? Big U.S. tax cuts, synchronized global growth, and strong earnings may face increasingly strong headwinds from U.S. Federal Reserve (the Fed) rate hikes, rising inflation, and protectionist threats. For now, the cycle tailwinds are stronger than the headwinds, but we believe this balance could shift as soon as the midway point of the year as the Fed continues to lift rates.

Q2 forecast: Tailwinds to outpace headwinds … but for how long?

It’s been an eventful start to 2018 for global financial markets. The 5.6% rise for the S&P 500® Index was the biggest January gain since 1997.1 This was followed by the largest ever one-day spike in the CBOE Volatility Index (the VIX), the first 10% market correction since early 2016 and a subsequent 8% rebound.2 To top it all off, the U.S. 10-year Treasury yield rose 50 basis points to 2.90%—the highest since the taper tantrum of late 2013.3  Strong Q4 corporate earnings and a much larger-than-expected Trump fiscal stimulus provided the initial boost, but this was undone when a spike in average hourly earnings, released with the January payrolls data, triggered an inflation scare.

The end result? 2018 looks different from last year along a number of significant fronts:

  • More fiscal stimulus adding to already strong global growth momentum.
  • Labor market inflation pressures, centering on the U.S.
  • Central banks becoming more hawkish, with the U.S. Fed potentially hiking four times this year and the ECB preparing to wind down quantitative easing.
  • President Trump turning out less protectionist than feared during his first year in office— although he’s now implementing tariffs.
  • More market volatility, implying larger risk premiums across asset classes.
  • This adds up to a complicated late-cycle backdrop for markets. Our view is that, for now, the cycle tailwinds from synchronized global growth, strong earnings-per-share gains, and fiscal easing outweigh the growing headwinds from monetary tightening and inflation pressures.

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