By Cliff Waldman, Chief Economist, MAPI Foundation
Recent turbulence in the stock market is a wake-up call to manufacturers, and to all businesses. The measurable rise in the yield on the 10-year Treasury note, now at the highest level in four years, has arguably been the primary catalyst for the equity market rout. This rise spurred to some extent by credible hints that long-dormant inflation might be on the cusp of increasing, has been a signal that financial conditions will eventually, and perhaps quickly, tighten to more normal levels. That message became all the more potent with the release of the January report on consumer price inflation. The inflation report, which showed price pressures to be a bit stronger than expected, spooked investors in the same way that the strong January jobs report, with a hint of strengthening wage gains, did.
As is the case with many macroeconomic variables, a shift in inflation is a double-edged sword for business. The rise in inflation means that input costs will rise for manufacturers. But it also means that a measure of pricing power will return. Higher interest rates mean higher financing costs. This will vary by the size of the business and creditworthiness, but all businesses will be impacted to some extent.
Signs of inflation pressures such as the rise in interest rates and the return of significant stock market volatility create uncertainty about the near-term path of monetary policy, particularly as Chairman Powell assumes his position. That has consequences for the general economic outlook and thus for business revenue. Right now, Fed policy is very much at a fork in the road. If financial markets remain exceptionally jittery, the Fed may postpone further rate increases and could even be forced to provide liquidity to support market adjustments. But if the Fed reads the rise in bond yields as signifying that they are behind in their efforts to adjust the short end of the yield curve properly, then a more hawkish policy may be deemed appropriate. Much will depend on market activity through the first quarter of 2018 as well as the inflation reports of the next few months.
It is clear that business decision makers must be aware of an imminent rise in inflation and the current rise in interest rates. Plans must be made for higher financing costs and higher input costs. At the same time, savvy executives should work to capitalize on a friendlier pricing climate. Provided that the Federal Reserve acts to adjust its part of the yield curve with calm guidance and clear communication, the emergence of stronger growth is unlikely to be derailed by the normalization of financial conditions.