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%.
Pity the poor Federal Reserve. In making decisions about interest rates–in this case about whether or not to raise interest rates at its June, July or September meetings–it has to consider the condition of both the real economy and the financial markets.
And right now the two realms are sending out different signals.
The real economy seems to be in good shape, the disappointing 38,000 increase in jobs in May not withstanding. The financial markets not so much so.
You figure out how the Fed is going to split the difference.
In the real economy today’s report from the Commerce Department showed that retail sales in May grew by a better than forecast 0.5%, after a 1.3% increase in April. (The April gain was the biggest in a year.) The means retail sales have now posted their best back-to-back monthly gains in two years. Wall Street analysts have moved today to increase their estimates for annualized growth in household spending to 3.7% from 3.4% (Barclays), and 3.6% from 3.2% (Credit Suisse.) Household spending grew by just an annualized 1.9% in the first quarter.
Absent a surge in job growth, the big increase in retail sales and household spending is coming from wage growth. The economy may not have created many jobs in May, but companies aren’t laying off many people either and they’re paying more to keep their current workers on board.
The Federal Reserve Bank of Atlanta’s wage growth tracker shows wage growth accelerating since October 2015 to a pace not seen since January 2009. The median U.S. worker saw a 3.5% year over year pay increase as of May. That is another indicator that the U.S. economy may be nearing full employment. Anecdotal evidence from individual companies is that finding quality employees is a getting harder with the NFIB Small Business Optimism report for May putting the share of owners unable to fill a job opening at historically high levels.
On the other hand, financial markets struggling. U.S. stocks have pulled back (as expected) from an attempt to set an all time high on the Standard & Poor’s above 2135. More worryingly, the spread between the yield on 10-year U.S. Treasury notes and two-year notes is the narrowest since 2007. Such flattening of the yield curve can signal an impending recession. Deutsche Bank analyst Steven Zeng, for example, now puts the odds of a U.S. recession at 55% within the next 12 months. If that’s a real possibility, the last thing the Federal Reserve would want to do is potentially accelerate the arrival of a recession by raising interest rates. I think there are good reasons to think that the bond market signal is wrong. The big moves along the yield curve are also responding to changes in demand for different maturities of Treasuries because of new financial regulations and worries over the Brexit vote in the United Kingdom on leaving/staying in the European Union. Money is sloshing around seeking safety in a world with major financial uncertainties.
That’s my sense of the signs at the moment. The situation is very fluid. Uncertainty is high. And that in itself is likely to lead the Federal Reserve to wait before making any decision. The Fed’s next rate setting meeting is scheduled for Wednesday June 15.
There wasn’t much in the economic data today to make the financial markets reconsider their belief in the return of Goldilocks. Global growth numbers supported the view that key world economies will turn in decent performances. But none were so strong as to suggest putting higher interest rates from the Federal Reserve back on the schedule.
Imports in China increased by 5.1% year over year in May. That’s not stunningly impressive growth but it does mark the first time that imports have moved up after 16 months of declines.
U.S. benchmark West Texas Intermediate and international benchmark Brent crude rose 1.59% and 1.94%, respectively, as of 3 p.m. New York time as U.S. oil inventories fell by 3.2 million barrels for the week. That kept the trend pointed in the right direction but the drop, reported by the Energy Information Administration today, was only slightly greater than the 3.1 million barrel decrease predicted by energy analysts surveyed by the Wall Street Journal. Again good news but not too much of it.
As of 3 p.m. the Standard & Poor’s 500 stock index was ahead 0.37% to 2119.87 as it continued to close in on the May 2015 all-time high of 2135. The dollar continued to weaken on the belief that the Federal Reserve won’t raise interest rates until September.
So strong is the current Goldilocks view that financial markets were willing to completely overlook any contrary data points.
For example, the World Bank slashed its 2016 global growth forecast today to 2.4% from its 2.9% forecast in January. The forecast for commodiy-exporting emerging markets dropped to a very small 0.4% growth rate for 2016. That is down from a forecast of 1.2% growth back in January. Commodity importing emerging markets will do much better on lower energy and other commodity prices. But even in that segment of the global economy, the World Bank lowered its 2016 forecast, dropping its expectations to 5.8% from the previous 5.9%.
Forecasts for developed economies took a hit as well with projections for the United States falling 0.8 percentage points to 1.9% growth in 2016. Projections for the EuroZone economy dropped to 1.6%.
Among individual emerging market economies, the forecast for China remained unchanged at 6.7% in 2016. (That comes after growth of 6.9% in 2015; the World Bank expects growth in China’s economy to drop to 6.3% by 2018.) Economic growth in India, at a projected 6.7%, stayed in line with January forecasts. The current recessions in Brazil and Russia were projected to be even deeper in 2016 than was forecast back in January.
Goldilocks will get a significant gut-check tomorrow, Thursday, June 9, with the release of the weekly numbers on initial claims for unemployment. If the number of new claims filed remains at the low level of the last few months, then some investors will question the weak May jobs number released last Friday and the consensus that the Fed has moved to the sidelines on interest rates until at least September. A much higher level of new claims will stoke fears that the U.S. economy might be headed to recession. A rising level of new claims frequently signals that the job market has stalled and that the economy might be headed toward a recession. Economists surveyed by Bloomberg are looking for the weakly number to rise slightly to 270,000 from the 267,000 of the prior week, but that would not be a big enough increase in new claims to set off alarm bells. Economists note that initial claims from oil producing states have stopped rising and are now declining–which makes an increase in initial claims on the national level less likely.
Today the market has decided that the Federal Reserve has delivered a new round in the Goldilocks market. Yesterday’s speech from Federal Reserve chair Janet Yellen, promised, as the markets heard it, continued decent growth in the U.S. economy, restraint from the Fed on the next interest rate increase, and a weak dollar that would produce higher commodity prices and better overseas earnings for U.S. multinationals.
Given this perfect story, almost everything is up. The Standard & Poor’s 500 continues its advance on the all-time high of 2130 set back in May 2015. At 3:45 p.m. New York time the S&P 500 was up 0.28% to 2115.39.
Oil was up with U.S.benchmark West Texas Intermediate climbed 1.59% to $50.48 a barrel and the international Brent benchmark climbed 1.88% to $51.50 a barrel. Commodities as tracked by the Bloomberg Commodities Index are now in a bull market having gained 20% from the January low.
The U.S. dollar weakened, falling 0.4% against the 10 currencies tracked by the Bloomberg Spot Dollar Index. Treasuries and other sovereign bonds rose as yields fell. The yield on the 10-year Treasury note dropped to 1.71% as investors and traders decided that even if the Fed does raise interest rates, it will do so more slowly than previously forecast. (This is, in other words, a bet on very slow but not completely stagnant economic growth.) The yield on 10-year German bunds fell four basis points to a record low of 0.48%.
On the weaker dollar, emerging market assets gained with the iShares MSCI Emerging Markets ETF up 0.86%.
I don’t see news likely to disturb Goldilocks until next week when the Federal Reserve meets. The U.S. central bank is extremely unlikely to raise interest rates at this meeting but the Fed’s press statement and Janet Yellen’s press conference could include something that might call the consensus story into doubt–at least enough to dent the current complacency. After that, the Brexit vote on June 23 could, if the United Kingdom votes to leave the European Union, roil markets. The likely reaction to that vote would be a move to low-risk assets such sovereign bonds, the yen, and maybe the dollar.