Supply and demand always have and always will be the basic levers in the market. Additionally, interest rates temper or imbue demand and inflation is a reflection of raising asset prices. On the demand side, there is real GDP growth and the value of the dollar. GDP growth has been lackluster for the last few years which is why the FED has been reluctant to raise rates. GDP growth is looking to be 2.4% for 2017 which is a modest recovery from 2016 (2.1%).
Some people are extremely worried that the FED is going to raise rates dramatically causing a drop in the stock market and other assets. But why would the FED raise rates if GDP growth is still lagging and inflation is below their target of 2% and is only at 1.6% for 2017? Inflation has been very stubborn as even hotly contested quantitative easing strategies struggled to raise inflation. In Ray Dalio’s opinion (Bridgewater Associates), this is because consumers are unconvinced and are reluctant to spend their money the way they used to. The other variable affecting demand is the strength of the dollar. After the financial crisis of 2008 and more recent geopolitical risks, America has been deluged with foreign capital. People around the world are looking for a safe haven for their money and have found it largely in American assets such as real estate, public markets and private equity. The influx of capital chasing dollar denominated assets has raised valuations while our domestic growth remains modest.
Additionally, the dollar is strengthened by increased demand by foreign investment and sovereign wealth funds. A strong dollar hurts our export business and places other strains on the US economy such as, “A strong dollar depresses oil prices. That’s because oil contracts are priced in dollars. Oil companies are laying off workers, and some may default on their debt. High yield bond funds haven’t done well as a result” (Amadeo). All of this information shouldn’t scare you but rather scare off the FED from raising rates too aggressively which is a very good thing. This keeps the economy stable and allows for current growth markets to continue to grow. The article quoted above debunks the idea of a potential housing crisis. Kimberly Amadeo quickly dismisses this idea as 2017 looks nothing like 2007. Consumers in the US don’t display anything close to the levels of exuberance they did in 2007. The real estate market is in a fine place and described nicely as priced to perfection.
Referenced Article: https://www.thebalance.com/us-economic-outlook-3305669