My family and I move every 20 years or so whether we need to or not, so on Wednesday when the Fed was making its decision to keep interest rates right where they are, I was busy unpacking all the boxes that we’d packed on Tuesday. (I’m sooo looking forward to the day when you can digitize everything you own, upload it all, and then download to your new location. I’d definitely pay $1.99 for an app that did that.)
Anyway, with the benefit of hindsight–and moving- induced exhaustion–I have to say that the nothing that Fed did on Wednesday was actually extremely important as an indicator on a potential September interest rate increase.
While it did nothing on Wednesday to change interest rates, the U.S. central bank said quite a lot about the U.S. economy. The economy, the Fed said, had overcome uncertainties to achieve what looks like a sustainable moderate rate of growth. Job growth has pushed the economy to something close to full employment. And, the Fed added, it sees fewer clouds on the horizon for the U.S. economy.
This isn’t a formula that guarantees an interest rate increase when the Fed next meets on September 21, but this language does clear the way for a possible interest rate increase.
The problem facing the Fed, though, remains the same: After all the stimulus that the Fed has provided for the U.S. economy, where’s the growth?
Inflation is well below the Fed’s target of 2%. The economy shows no signs of breaking out of its low growth rut. Maybe Friday’s first read on second quarter GDP growth will come in at the 2.6% rate that economists were expecting last week, but current forecasts are looking for growth closer to 1.8%, and that would still leave the U.S. economy looking back at growth of less than 2% for the first and second quarters of 2016 and the last quarter of 2015.
Maybe, the Fed has to be wondering now, the speed limit on the U.S. economy has been lowered to 2% instead of 3%. Maybe current growth is about as good as this economy–domestic and global–can deliver. And if that’s the case, what’s the point, exactly, of raising interest rates? To make sure that growth stays well below 3%? To head off nonexistent inflation?
In these circumstances and with this data, the Fed is being asked to figure out not just what is happening but why. Are we in for a long period of slow economic growth because something has changed in the US. and global economy?
The Fed would like to know.
I’m sure investors would like to figure out an answer too–since the answer has major implications for portfolio design and risk taking.
At the moment the Fed funds futures market hasn’t raised the odds for a September move beyond the 18% or so of the days before the Fed meeting.
Ignore the volatility in the monthly jobs numbers–this economy is about where it should be for this point in the cycle
Here’s the smartest thing I’ve read about today’s news that the economy added 287,000 jobs in June, way more than the 180,000 consensus among economists surveyed by Bloomberg:
“The bottom line is that seeing through the month-to-month volatility, the U.S. job market is healthy and job growth [on average over the last three months]–at nearly 150k – is right as rain at this point in the economic cycle,” Michael Dolega of the Toronto-Dominion Bank said to Bloomberg.
What makes this so smart?
First, Dolega emphasizes the longer term trend over the monthly gyrations in the numbers. At the same time as government statisticians announced the creation of 287,000 jobs in June, they also revised May’s already shockingly weak 38,000 job figure down to just 11,000. That leaves us looking at a swing from 11,000 to 287,000– or 276,000 jobs in a month. An $18 trillion economy just doesn’t move that fast. So somewhere in the month to month data there’s a statistical glitch.
If instead we look at the smoothed average over the last three or six months we get a much more useful and accurate picture of the economy. Over the last three months on average the U.S.economy has created 147,000 jobs. The average for the last six months is 172,000.
The average says that the U.S. economy didn’t either fall into a black hole in May or shift to warp speed in June.
Second, Dolega puts the monthly averages in the right context. This economy is late into a business cycle that began with the recovery from the bottom in 2009 of the global financial crisis. Economies coming off a bottom grow faster than economies that are in Year Seven of a recovery. You can see that by comparing the 2016 six-month average for jobs to that average for 2015 and 2014. The six-month average for jobs created is 172,000 in 2016 but 229,000 in 2015 ands 251,000 in 2014.
As recoveries age it simply becomes harder to put anyone still out of work to work as the economy reaches whatever number represents full employment at that moment. Most people looking for work have found it and many of those still looking don’t have the skills that employers want. It’s not especially shocking that the official unemployment rate climbed to 4.9% in June from 4.7% in May.
All this argues that today’s surprisingly strong 287,000 figure isn’t likely to impress the Federal Reserve as much as some parts of the market seem to think today. The Fed will, of course, be glad to have solid evidence that the U.S. economy isn’t headed over a cliff. But today’s numbers still leave the U.S. central bank uncertain–with all uncertainties such as Brexit considered–how fast a U.S. economy at this point in the business cycle is likely to grow. And how likely it might be that an interest rate increase might take too much steam out of the economy.
At the close in New York the Standard & Poor’s Stock index was up 1.36%%. Crude was modestly higher with West Texas Intermediate bumping up 0.27% to $45.41 a barrel and Brent crude rising by 0.78% to $46.76.
The Brexit vote in favor of ending the United Kingdom’s membership in the European Union effectively took Federal Reserve interest rate increase off the table for July, and September, and November. And maybe even December. Remember that the process of exiting the European Union is a long one–and the two-year deadline for a departure doesn’t even get started until a U.K. government asks for an exit. We could still be in the scary, early, nobody knows what’s happening stages of an exit come December. (This post originally appeared on my subscription site JubakAM.com on Saturday June 25.)
And if a Federal Reserve interest rate increase is off the table for that long and global financial markets remain unsettled for that long and growth in the global and U.S. economy is going to be lower than projected just a month or so ago, I think it’s time to rethink exactly how low yields on the 10-year U.S Treasury can go.
The logic here is pretty simple. In an uncertain financial market investors and traders look for safety in assets such as Japanese government bonds, German bunds, and U.S. Treasuries.
As long as the threat of a Federal Reserve interest rate increase was a real danger, putting cash into Japanese government bonds and German bunds had a certain attractiveness over buying U.S. Treasuries. A hike in U.S. interest rates could send the price of existing Treasuries lower. The end of that threat from the Fed for the months ahead removes that disadvantage.
And that allows the big yield advantage of U.S. Treasuries to come to the fore. The yield on a ten-year U.S. Treasury was 1.56% as Friday, June 24. That compares to a negative 0.17% yield on the 10-year German bund and a negative 0.185% yield on the 10-year Japanese government bond.
If you are looking for safety and would actually like to make a little bit of money while you sit on near-cash, what do you think is more attractive right now? Collecting 1.56% in U.S. Treasuries or paying 0.17% or 0.185% to hold German or Japanese government bonds, respectively.
Which is why bond managers are forecasting a new drop in yields for U.S. Treasuries in the months ahead. Do remember that a drop in yield works out to an increase in the price of Treasuries.
The consensus among these Treasury bulls is that the yield on 10-year Treasuries is likely to drop to something like the 1.38% historic low of July 2012 or even further to a new historic low near 1.25%.
What would a drop to 1.38% or 1.25% from today’s 1.56% yield mean to bond prices–and the gains that bond buyers can think about?
If the yields on 10-year Treasuries fall to 1.38%, the price of a $1,000 Treasury bond would rise to $1130.44 for appreciation of 13.4%.
If the 10-year Treasury yield falls to 1.25%, the gain would be 24.8%.
Mind you I wouldn’t count on Treasury yields falling to match the historic low or to bust through that low to 1.25%. But it won’t take a drop all the way to those levels to make this a profitable position, especially when the U.S. and global economy look weak enough to keep returns from equities to very low levels.
You can, of course, buy Treasuries directly in the market or from the U.S. Treasury itself. And there’s no reason not to–the process is very easy. Or you can make it even simpler for a very modest fee by buying an ETF such as the iShares 7 to 10 year Treasury Bond ETF (IEF.) The expense ratio is a low 0.15%. For the year to date total return on this ETF is 7.06%, which certainly beats the 0.32% return for the Standard & Poor’s 500 stock index. Currently the ETF yields 1.58% and it pays dividends monthly.
I’m going to add this ETF to my Jubak Picks 12-18 month portfolio on Monday, June 27.
Just as British bookmakers are soothing some of our financial market angst over the results of Thursday’s Brexit vote, Federal Reserve chair Janet Yellen is turning up the anxiety meter.
Bookies in the United Kingdom–and the cash being placed with them as bets–now give “stay” with the European Union an 82% chance of winning the referendum. According to big U.K. bookmaker Ladbrokes, 95% of the bets placed Monday were wagers on a failure of the “leave” position in the referendum. (Official polls remain split on the results of the vote.)
You might have expected a big rally–like yesterday’s–on the continued shift in the odds but the markets aren’t seeing it. As of 3:30 p.m. New York time, the Standard & Poor’s 500 stock index was up just 0.37% to 2091.04 as it continues to lag both resistance at 2100 and the 2135 all-time high. West Texas Intermediate was off 1.05% to $48.85 a barrel; the Brent crude benchmark held up better, dropping just 0.19% to stay above $50 a barrel at $50.46.
What’s the matter markets? Afraid to feel the joy of a likely defeat of the Brexit side in the vote? (Granted, it’s never over until the fat lady sings.)
Give credit to a subtle but none the less profoundly negative shift in the testimony that the Fed’s Yellen delivered to the Senate today. (She’ll complete her semi-annual Congressional tour with the House tomorrow.)
Basically what Yellen said today is that the Fed is on watch to see whether the U.S. economy will show signs of improvement in growth. That’s a significant shift from last week when Yellen talked about watching to see when the economy showed signs of improvement.
“Proceeding cautiously in raising the federal funds rate will allow us to keep the monetary support to economic growth in place while we assess whether growth is returning to a moderate pace, whether the labor market will strengthen further, and whether inflation will continue to make progress toward our 2% objective,” Yellen said.
Odds of a U.S. recession remain low (Whew!) Yellen told the Senate Banking Committee, but a slowdown in hiring in May, and weak growth in first quarter GDP have made the Fed much more cautious.
And it’s not just Yellen. James Bullard, head of the St. Louis Fed, and until recently one of the strongest voices arguing for an interest rate increase, published a paper last week suggesting that the U.S. economy could be stuck in a rut for the next two to three years.
Two to three years? Okay delaying the next interest rate increase until 2017 does send a thrill through parts of the financial markets (especially the bond markets) but I don’t think there’s anyone out there rooting for two to three years of economic growth so slow that the Federal Reserve can’t raise rates by even a quarter of a percentage point.
I still suspect that an actual win for the “stay” forces in Thursday’s Brexit vote would produce a surge in the markets. But Yellen’s remarks have certainly primed market for a major rethink after the vote.
And I wouldn’t make too much of a single minor data points like this but I wouldn’t totally ignore it either. On a day when the odds for a major market upheaval from Brexit have retreated, the S&P Volatility Index, VIX, has actually inched ahead rising to 18.47, up 0.54%.
Seems like not everybody is swigging the happy juice today.
To no one’s great surprise, the Federal Reserve, decided to hold interest rates steady at the current range of 0.25% to 0.5%. All 106 economists surveyed by Bloomberg before today’s meeting of the Fed’s Open Market Committee expected the Fed to leave interest rates unchanged.
The markets were, however, surprised by how dovish Fed Chair Janet Yellen sounded in her post-meeting remarks. As expected she noted the uncertainty added to global financial markets by next week’s Brexit vote in the United Kingdom. A decision by the country’s voters to leave the European Union has the potential to roil the world’s financial markets. But Yellen also added a litany of U.S. economic bad news to justify keeping rates where they are now–and potentially for quite some time. Business investment, even outside of the energy sector is slow. Growth in the labor market has slowed. Headwinds from the global economy are blowing strongly against the U.S. economy. All this means that interest rates should stay where they are now–and that interest rates should rise only very gradually once they start to rise.
Now the Fed has said almost exactly that before–but “gradually” looked to be more gradual today. The median opinion of 17 Federal Reserve policy makers is still looking for two interest rate increases in 2016, but the number of Fed officials who see just one interest rate increase in 2016 climbed to six from one at the last meeting. The median projection for interest rates by the end of the year remained at 0.875% (or two interest rate increases in 2016) but the median long-term projection for interest rates in 2018 fell to 3% from 3.3% back in March.
Initially the U.S. stock market reacted to all of this as good news. Lower rates for longer? Yippee! The Standard & Poor’s 500 was up by as much as 0.5% after Yellen spoke.
But then the market had second thoughts. If interest rates stay the same, then all that remains to drive stocks higher is company earnings. And those aren’t likely to be any too robust in the slow growth economy that Yellen described. On these second thoughts, the S&P 500 declined to finish the day lower by 0.2%.