Why there might be a downside to a strong US economy

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Nov. 20 2020, Updated 5:07 p.m. ET

Of course, a strengthening U.S. economy may have a downside. If the Federal Reserve (or Fed) increases interest rates too soon or by too much, markets could be rattled. Another trend to watch: diverging growth. Europe and Japan are still struggling, while the U.S. continues to evidence signs of strength.

Market Realist – Strong economic data for the U.S. might compel the Federal Reserve to hike rates sooner than expected. In its September Federal Open Market Committee (or FOMC), the Fed stated that it would keep rates low for “a considerable time” even after the conclusion of its bond buying program (TLT) in October. The bond buying program was introduced to counter the recession caused by the U.S. financial (XLF) crisis of 2007–2008.

fed funds rate

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Market Realist – The Fed currently fixes the federal funds rate between 0% and 0.25%. The graph above shows the effective federal funds rate in the past ten years. The strong economic data could compel the Fed to hike rates as early as the first quarter of 2015. This is earlier than the U.S. markets expect. This would not only adversely affect the U.S. equity (SPY)(IVV) and bond markets (BND) but also have repercussions for international markets (QWLD)(URTH).

GDP growth divergence

Market Realist – The graph above shows the GDP growth rates for the U.S., Japan, and the Eurozone. While the U.S. economy was able to recover from the slowdown we saw in the first quarter and showed 4.6% growth in the second quarter, the Eurozone (EZU) saw a complete halt in growth with a 0% GDP growth rate. Japan (EWJ) saw a negative growth rate of -1.8% in the second quarter this year due to the introduction of a consumption tax in April, which led to a slowdown.

This divergence in growth is causing divergence in monetary policies as well. While the Fed’s looking to end its QE program in October, the European Central Bank has announced its purchase of asset-backed securities beginning this quarter. The Bank of Japan too is expected to adopt an easy and accommodative monetary policy to stimulate the economy.

Read on to the next part of this series to see how you can reposition your portfolio for the last quarter of the year.

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