Respondents to the CNBC Fed Survey foresee good times for the economy and the stock market, but they have put an asterisk next to those predictions because of growing concerns over a trade war and monetary policy.
Growth year over year is seen rising nearly 3 percent in 2018, before dropping to 2.7 percent in 2019, and the S&P 500 is expected to rise about 6 percent by year-end. Inflation is seen staying low along with the unemployment rate, and the yield on the 10-year Treasury note will rise only to 3.5 percent by the end of 2019.
"Goldilocks is alive and well," wrote Marshall Acuff, managing director at Silvercrest Asset Management, in response to the survey.
But several significant clouds hang over most forecasts. Almost two-thirds of the 42 respondents, including economists, money managers and strategists, see the recent economic strength as temporary. And 53 percent peg protectionist trade policies as the biggest threat to the economy.
While 59 percent approve of President Donald Trump's handling of the economy, an equal percentage say his trade policies will reduce economic growth, and 54 percent say it will reduce employment.
"While the U.S. economy still has solid growth potential in front of it, you still get the sense that it wouldn't take much to watch it derail, with a high degree of confidence that Washington will be the cause of the derailment with its trade policies or some poor decision-making at the top," said Kevin Giddis, head of fixed income capital markets, Raymond James Financial.
On average, respondents say the existing tariffs will whittle down growth only by 0.1 percentage point. But the additional tariffs threatened by the Trump administration along with possible retaliation from trading partners could reduce gross domestic product by another 0.3 percentage point.
Concerns about trade helped push up the probability of a recession in the next year to 16.8 percent, the highest in seven months though still relatively low by historical standards. Worries about Federal Reserve policy could also be playing a role.
"Rising interest rates and (balance sheet reduction) remain the biggest risk to the entire economic and market apple cart," said Peter Boockvar, chief investment officer at Bleakley Advisory Group. "A soft landing is a rare occurrence and considering the extent of the prior easing, the Fed's job challenge of achieving one is even more remote."
Nearly 70 percent of respondents see two more rate hikes this year, an increase from the June survey, and most see an additional two or three quarter-point hikes in 2019. What's more, 53 percent believe that the Fed will move rates up to a level that would explicitly slow the economy, that is, beyond neutral. The Fed Funds rate is forecast to rise to 2.9 percent in 2019 and 2020 and eventually to 3.3 percent in the long run. The average estimate for the long run is now almost 65 basis points higher than it was a year ago.
"The good news for the FOMC is that they have essentially reached their dual mandate for full employment and near 2 percent inflation," wrote Kathy Bostjancic, head of U.S. macro investor services at Oxford Economics USA. "The challenge is maintaining that nirvana, which means not tightening too much or too little."
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