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Market Commentary, December 18, 2017 For the week of December 18, 2017

Key Market Data

12/08/2017 12/15/2017 One Week Change YTD One Year
S&P 500 Index 2,651.50 2,675.81 +0.92% +21.86% +20.69%
MSCI EAFE Index 2,005.31 2,007.97 +0.13% +22.97% +24.52%
Barclays Capital U.S. Aggregate Bond Index 2,042.43 2,048.32 +0.29% +3.64% +4.69%
10-year Treasury Note Rate 2.377% 2.354% -2.3 basis points -9.1 basis points -24.4 basis points

President Donald Trump and the GOP have been promising Americans a tax cut, and it seems increasingly likely to be under the tree this year after Republican negotiators won over some skeptical senators on Friday.

Investors responded by driving the S&P 500, the Dow Jones Industrial Average and the Nasdaq to record highs as the week ended, with the shares of companies most likely to benefit from the tax cuts, small businesses and financial firms, leading the charge. Meanwhile, the yield on the 10-year Treasury fell to 2.354%, lower than at the start of the year, despite three rate hikes by the Federal Reserve, partly because inflation remained weak.

At midweek, the passage of the tax plan seemed to be in jeopardy after Senator Marco Rubio (R, Florida), among others, said he wouldn’t vote for the bill that the House and Senate had agreed on until changes were made. With few votes to spare, the math in the Senate was further complicated by the fact that Senator John McCain (R, Arizona) is hospitalized; that Bob Corker (R, Tennessee), the lone GOP senator to vote against the plan when it passed the Senate, was still on the fence; and that a Democrat won a special senatorial election in Alabama, which means that the GOP’s edge in the Senate will be cut to 51-49 early in 2018. But Republican negotiators won Rubio over with last-minute changes to increase the child tax credit, and Corker also pledged to vote for the plan, giving it the margin it will need to pass, presumably this week. The Republicans have said that the bill, which will sharply reduce the corporate tax rate, will spur growth, create jobs and improve American competitiveness. However, no Democrat in either chamber is expected to vote for the plan, which they have denounced as benefiting the rich, only offering short-term tax cuts for most Americans, gutting such programs as Obamacare, and adding $1.5 trillion to the national debt.

The Fed acts, as expected

The tax cut talk all but overshadowed another big story last week when the Fed, as widely expected, raised its benchmark rate for the third time this year, increasing the rate one-quarter point to a range of 1.25% to 1.50%. Two Fed officials, neither of whom will be voting committee members in 2018, voted against the hike. In addition, the Fed said it plans to make another three cuts in 2018, and announced that inflation is not expected to reach its target of 2% next year. The Fed also weighed in on the tax plan, saying it was likely to provide a “modest lift” for the economy, and forecast growth of 2.5% in 2018, up from its previous estimate of 2.1%. Even so, Yellen said, “We continue to think that a gradual path of rate increases remains appropriate even with almost all participants factoring in their assessment of the tax policy.” At her post-meeting press conference, Yellen, who will step down when her term ends in February, praised her successor Jerome Powell, saying he was “somebody who understands the Federal Reserve very well and shares its values.” When asked about her own legacy, Yellen described her time at the Fed as “immensely rewarding,” adding, “I feel good that the labor market is in a very much stronger place than it was eight years ago.”

The ECB does not follow the Fed

While the Fed raised its rate yet again, the European Central Bank (ECB) left its rate unchanged, even though the bank’s President Mario Draghi said there had been “a significant improvement in the growth outlook.” The bank has, however, already scaled back the size of its monthly purchase of government and corporate bonds. However, the purchases will continue through at least September 2018 and could be increased if the eurozone’s economy falters. The ECB also said that inflation will remain below 2% through 2020.

The Brexit

European Union leaders have given the green light to Brexit talks with Great Britain, but they also told Britain’s Prime Minister Theresa May to tell them precisely what she wants, before discussions begin in March. May, who still faces challenges within her own party, said, “Today is an important step on the road to delivering a smooth and orderly Brexit and forging our deep and special future partnership.” This came during a week when, over her protestations, Parliament voted to give itself a final say on any Brexit deal by a narrow 309-305 margin.

Disney makes a move

Disney announced that it would pay $52.4 billion in stock to acquire most of 21st Century Fox last week, creating a media colossus that some see as likely to spur future industry consolidation. Disney will also assume $13.7 billion of Fox’s debt. The deal may face federal scrutiny, especially as the government recently moved to block AT&T’s acquisition of Time Warner. In other news, the Commerce Department said that retail sales rose 0.8% in November from the month before. Industrial production improved 0.2% in November from October’s upwardly revised gain of 1.2% and was up 3.4% from a year earlier, while manufacturing rose the same 0.2%; capacity utilization was 77.1%. The Producer Price Index (PPI) rose 0.4% in November from the month before and was up 3.1% over the past year; core PPI, less food and energy, increased 0.3% from October and 2.4% for the last 12 months. The Consumer Price Index (CPI) gained 0.4% in November from October and 2.2% for the year; core CPI was up 0.1% month over month and 1.7% over 12 months. The National Federation of Independent Business Index of small business optimism climbed 3.7 points to 107.5 in November, the second highest reading in the index’s 44-year history. And first-time jobless claims for the week ending Dec. 9 fell 11,000 to 225,000; the four-week moving average dipped 6,750 to 234,750. Lastly, if the Organization of the Petroleum Exporting Countries keeps its output at the current level, the United States will pass Saudi Arabia as the world’s leading crude oil producer during 2018.

A look ahead

In addition to the progress of the tax plan, this week will see updates on housing starts and building permits, the current account balance, existing and new home sales, consumer confidence, and personal income and spending. The government will also release its second estimate for third-quarter gross domestic product, forecast to remain unchanged at 3.3%.

All of us at Northwestern Mutual wish you and your family a happy and healthy holiday season.