The speeches, interviews, and presentations from members of the Federal Reserve keep on coming. And they all say, “We’re prepared to raise rates soon.”
Over the weekend Eric Rosengren, head of the Federal Reserve Bank of Boston, told the Financial Times that he’s ready to back a rate increase.
The heads of the St.Louis, San Francisco, and Philadelphia Federal Reserve banks are due to speak today. (Update: In his remarks today Patrick Harker, head of the Philadelphia Fed, said he could see as many as two or three interest rate increases in 2016.)
Fed chair Janet Yellen is on tap for a speech on Friday.
All this speechifying has driven the odds for an interest rate increase at the Fed’s June 15 meeting to 32%, according to Bloomberg’s calculation, from as low as 4% before the release last week of the Fed’s minutes from its April meeting.
And all this talk makes Friday’s announcement of revisions to first quarter GDP growth even more important. Right now economists are looking for the revision to increase the growth rate to 0.9% from 0.5%. That would be a “fact” to back the Fed’s argument that the economy is strong enough to take an interest rate increase in stride. And that the first read on first quarter growth would be succeeded by stronger growth in the second half of the year.
The Standard & Poor’s 500 finished down a slight 0.21% for the day, against dropping below the 2050 level that has been support for this market recently.
This morning the Labor Department announced that the U.S. economy had created just 160,000 jobs in April. That was disappointing. Economists had expected 200,000 net new jobs. In addition the Labor Department’s statisticians revised the reports for February and March to lower by a total of 19,000 jobs. The headline unemployment rate remained unchanged–expectations were looking for a drop in the rate. The only piece of good news was continued gains in wages. The month increase came to 0.3%, spot on estimates. That brought the annual increase to 2.5%.
Under some circumstances you’d expect a weak jobs number would send financial markets higher because it would signal that the Federal Reserve will put off the next interest rate increase.
But not today. The Dow Jones Industrial Average was off slightly, by 0.07%, as of 11:30 a.m. New York time. The Standard & Poor’s 500 slipped 0.18% and and NASDAQ Composite was lower by 0.45%. The dollar was down against the yen and the euro.
And that’s because the financial markets have already priced in a one or none scenario for 2016. And when you already believe the Fed isn’t going to increase interest rates at its June meeting, getting data that confirms that belief isn’t going to move prices higher. Yesterday traders were giving a June rate increase just a 13% chance, according to the Fed funds futures market. Wednesday those odds were at 9%. Today they’re at 6%. Not a significant difference–if you’ve placed your bets, there wasn’t enough in this morning’s data to make you change those bets.
The odds for a September interest rate increase have moved down to 36% today from 40.7% yesterday.
Which leaves the market to ponder where the revenue and profit growth might come from to drive stock prices higher–if expectations for lower longer interest rates aren’t going to do that job.
The S&P 500 hadn’t retreated much as of 11:30 but the 3.61 point fall in the index was enough to take it to 2047 and below support at 2050.
Seems Goldilocks might be getting a little uncomfortable.
On Friday morning, before U.S. markets open, the Labor Department will report job gains and unemployment for April. It will take a strong jobs number to offset recent weak reports on U.S. economic growth. And without a strong jobs report the Federal Reserve won’t have grounds for increasing interest rates at its June meeting. A strong report won’t guarantee an interest rate increase but if it unleashes a series of speeches from Federal Reserve members, then I think we will see the current very low odds of an increase at the June 15 meeting start to rise–along with volatility and the dollar. Stocks, domestic and emerging market, and commodities would be likely to move lower. (Right now the Fed futures market is pricing in just a 9% chance of a June rate increase.)
How strong would Friday’s jobs report have to be? My own survey of surveys of economists, TV interviews, and web posts argues that economists would call the creation of 200,000 new jobs, any drop in the unemployment rate, and monthly wage gains of 0.3% or more strong.
It’s not just the numbers that count, though. Markets (and yours truly) will be looking for evidence of the Fed’s reaction to these numbers to gage how likely a June move is. The Fed hates, especially when the economy is fragile, to surprise financial markets and an increase in June when traders and investors are giving such a move only a 9% chance would have to count as a surprise. If the Fed wants to move in June or even if the bank just wants to keep June on the table, Fed members will have to talk up the possibility of an rate increase after strong numbers on the labor markets after Friday’s news.
Or perhaps before. The Federal Reserve sees the jobs report before its public release on Friday so there is some chance that remarks during the rest of this week from Fed governors could be part of an effort to send the financial markets a message.
Which is why remarks reported today from Federal Reserve Bank of Atlanta President Dennis Lockhart are so intriguing–and possibly important. Lockhart told reporters at the Atlanta Fed’s financial markets conference that while he wasn’t leaning for or against the June rate increase he regarded two interest rate increases this year as “certainly possible.” The financial markets are currently pricing in just one–or none–increases in 2016. Lockhart said he still believes in the Fed’s forecast for solid growth in the last three quarters of 2016 as the market rebounds from first quarter weakness. Inflation is showing signs of firming, he added. And, finally, he noted, the Fed has a duty not to surprise the markets and that communications from the Fed between now and June should work to prepare the markets for a “realistic range of possibilities” for the June meeting.
Are Lockhart’s remarks themselves part of an effort to prepare markets? I’d say if we don’t see a strong communications push by the Fed in the next couple of weeks, it will be a sign that June is off the table and that we should turn our eyes to September.
Forecasts that the U.S. is headed into recession took another lump from the economic data with today’s release of the Labor Department’s report on initial claims for unemployment. For the week ended on February 13, new claims for unemployment fell by 7,000 to seasonally adjusted 262,000. That’s the lowest level of initial claims since November and below the projection of 275,000 new claims by economists surveyed by Reuters.
The four-week moving average, a less volatile read on the underlying trend, fell by 8,000 to 273,250 with last week’s report.
Again, no evidence from this report that the U.S. economy is about to shift into higher gear. But also no evidence that the economy is sliding toward recession.
Is this kind of indicator of modest growth enough to reassure the Federal Reserve about the underlying strength in the U.S. economy so that the Fed raises interest rates once or twice in 2016? That’s the big question right now since the market decided a week or two ago that the Fed wouldn’t raise interest rates at all in 2016 and that the first increase might not come until relatively late in 2017. It doesn’t take much in the way of economic strength–an upside in industrial growth yesterday and slightly stronger initial claims numbers today–to raise doubts about that consensus.
All it takes is a little doubt when the market isn’t pricing in any doubt at all.
Most technical indicators say we’re in a bear market. Whether you want to call it a rolling bear, or a consolidation, or pick nits since the Standard & Poor’s 500 as a whole hasn’t yet hit the down 20% territory now inhabited by many of former market leaders. (The February 12 issue of James Stack’s InvesTech Research newsletter does a superb job of summarizing the technical indicators pointing to a bear market. To check out Stack’s newsletter and/or subscribe go to investech.com)
But so far economic indicators aren’t pointing to a U.S. recession. Job growth and income growth are healthy. Although the Institute for Supply Management’s survey of purchasing managers in the manufacturing sector has fallen below the 50 mark that indicates contraction in the sector, the survey for the services sector hangs above that mark, despite recent weakness. In the housing sector the confidence survey for the National Association of Home Builders hasn’t shown the downturn that usually proceeds a recession.
This is a good moment to remember Nobel-prize-winning economist Paul Samuelson’s quip that “The stock market has forecast nine of the last five recessions.”
Why is this important?
Stocks can certainly experience a bear market without a recession so the fact that the economy may not enter a recession isn’t some kind of proof that stocks aren’t actually in a bear or headed for one. (The S&P 500 is hanging around a drop of 13% or so in a bad week–not bear market territory–but 60% of S&P member stocks are 20% or more off their highs.)
But the worst bear markets in terms of percentage drop and in terms of duration require a coincident recession. If the U.S. isn’t going to slide into recession, the bear that is breathing down our necks right now will probably resemble a deeper version of the 12.4% drop from the May 21 high of 2130.82 on the S&P 500 to the August 25 low at 1867.61.
By November 2 the S&P 500 had climbed back to 2109.79. Painful certainly but not terribly long-lasting.
To get a really, really painful and long-lasting bear you need to combine a drop in stock prices with a recession as we did in 2007, 2000, and 1980. The 2007 bear–and the Great Recession–took stock prices down 56.8% and lasted for 517 days, according to Yardeni Research. The 2000 bear resulted in a 49.1% drop and lasted for 929 days. The 1980 bear took stocks down 27.1% and lasted 622 days.
Now that’s pain–and the duration of that pain was enough to test–if not wash out–even the most steel-nerved of investors.
So the big question for 2016–after the horrendous start to the year–is will we get a U.S. recession in 2016?
I wish I could confidently scoff and say “No way,” but I can’t. I think a U.S. recession in 2016 is unlikely–but it certainly isn’t impossible.
The economy, I’m afraid could go either way–although I think the odds are in favor of “No recession.”
As I noted above job growth is very solid and income growth actually looks like it is starting to pick up. Low oil prices mean low gas prices mean more dollars in consumers’ wallets for spending on things other than fuel. The U.S. auto industry set a sales record in 2015 and doesn’t look poised to fall off a cliff in 2016. After it’s best year in a decade in 2015, the U.S. housing industry is forecast to see 1% to 3% sales growth in 2016. That’s not a house on fire but growth isn’t recession. U.S. interest rates are low–and I think it’s likely that the Federal Reserve will pause its rate increases until it sees signs that U.S. growth is a solid 2% or so. Right now forecasts call for earnings growth to resume in the second half of 2016 as year-to-year comparisons with the slow growth of the second half of 2015 make beating estimates easier. That would have a big positive effect on CEO confidence levels. That’s important because worried CEOs fire people and don’t invest in their businesses. A modest increase in oil prices to, say $45 a barrel, would take pressure off some oil companies and reduce worry over banks’ exposure to bad loans in the energy sector.
That’s not a forecast for rip-snorting economy in the second half of 2016–but it is a picture of an economy that isn’t in recession.
Unfortunately, none of those positive trends or news items is a lock. China’s economy, despite the current round of stimulus, is likely to continue to slow. The U.S. economy doesn’t look like it will get any help from Japan and a EuroZone growth recovery is possible but questionable and won’t produce big numbers in any case. Developing economies and commodity-oriented economies such as Australia and Canada are likely to struggle. There is the possibility of a beggar-thy-neighbor round of currency devaluations that would further hurt U.S. exports. We’ve got weak governments coping with big problems in the EuroZone, the Middle East, Russia, and Japan. And I certainly would never rule out that U.S. politicians might be something stupid in an election year that might hurt U.S. growth. Nor can I absolutely rule out the possibility that the Fed got it wrong when it decided to raise interest rates in December.
It’s going to be hard to tell what the economic trend line is over the next few months because beginning in March we’re likely to see splashy moves from the central banks of the EuroZone, Japan, and China. I think all three of these central banks are signaling that they will move strongly in the early spring to stimulate their own economies. The likelihood is that will rally stock markets for a while but then leave markets open to a return to the crisis of confidence that I see in the financial markets right now. To my eyes a big part of the current slide in global stocks markets is due to investors and traders losing confidence in the ability of central banks to produce growth in their economies or to prop up the prices of financial assets for very long. That could see us return to the current malaise after the failure of a promising rally in the spring. That kind of volatility will make it very hard to find a longer-term trend worth hanging onto.
I guess you could color me “hopeful” that the U.S. will avoid a recession–which would help investors avoid the worst kind of bear market–but worried that a recession is possible and that financial markets having lost faith in central bank policies will wander lower.