Will Fed Wait Until Dec to Raise Rates?

Seven years ago, the recession officially ended. According to the National Bureau of Economic Research’s (NBER) Business Cycle Dating Committee, the organization responsible for declaring the beginning and end of U.S. expansions and contractions, June 2009 was the nadir of the worst recession since the Great Depression. Yes, employment bottomed out six months after the official end date, but that NBER says that is to be expected, because a recession “is a period of diminishing activity rather than diminished activity.” In other words, although the economy was still weak after June 2009, with lingering high unemployment, it had expanded considerably from its trough 15 months earlier. Where does that leave us today? The U.S. has seen a sluggish recovery, but the economy is far better off than it was seven years ago, by almost every objective metric. That said, a seven year expansion seems ripe for a breather, which is why so many are worried about the next recession. Adding to the concern was a report last week from the World Bank, which downgraded global growth estimates. “Overall growth remains below potential” and “looking ahead, the prospects of global growth remain muted.”

As expected, the commodity exporters have been hit particularly hard, but even advanced economies are stymied by sluggish growth. U.S. GDP is likely to be about 2 to 2.2 percent this year, consistent with the pace experienced over the past few years and the last few jobs reports have shown deceleration.

Amid this environment, it’s hard to see how the Federal Reserve could possibly raise interest rates when it meets this week. Although many central bankers went on a speaking junket in May, telling us that the U.S. economy had shown enough progress that a rate hike would be appropriate in the “coming months,” but the recent jobs data, combined with the dour World Bank assessment, makes it nearly impossible for the Fed to budge this week.

Instead, it’s back to parsing the Fed’s accompanying statement, the updated FOMC projections and Chair Janet Yellen’s press conference, for any signals of when the next rate hike might come. The answer, according to Capital Economics, “depends on whether the weakness in payroll employment in not just May but April too was a temporary blip or the start of a more serious downturn.”

If hiring picks up and the U.K. votes to remain within the European Union on June 23rd, the next Fed meeting at the end of July could be a possibility, but it would be a long shot. The more likely possibility would be the September meeting. If not September, it’s hard to fathom Fed action in November, just days before the presidential election. Unless there is a big uptick in economic activity, the last policy of the year on December 13 and 14, the one-year anniversary of the first rate hike of this cycle, may be the first and only Fed rate increase of 2016.

MARKETS: As U.S. indexes flirted with all-time record levels, the real action was in the bond market. The yield of the 10-year U.S. treasury tumbled to 1.639%, the lowest close since May 2013. Additionally, yields of comparable bonds in Germany and Japan, fell to all time lows, as investors bet on the continuation of sagging growth and low inflation and found solace in the overall safety of the bond market.

• DJIA: 17,865 up 0.3% on week, up 2.5% YTD
• S&P 500: 2096 down 0.2% on week, up 2.6% YTD
• NASDAQ: 4894 down 1% on week, down 2.3% YTD
• Russell 2000: 1164, flat on week, up 2.5% YTD
• 10-Year Treasury yield: 1.639% (from 1.7% a week ago)
• July Crude: $49.07, up 0.9% on week
• August Gold: $ 1,275.90, up 2.7% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.38 (from $2.35 wk ago, $2.76 a year ago)

THE WEEK AHEAD:

Mon 6/13:

Tues 6/14:

FOMC Meeting Begins

6:00 NFIB Small Business Optimism

8:30 Retail Sales

8:30 Import/Export Prices

10:00 Business Inventories

Weds 6/15:

8:30 PPI

8:30 Empire State Mfg Survey

9:15 Industrial Production

2:00 FOMC Decision

2:00 FOMC Economic Projections

2:30 Janet Yellen Press Conference

Thursday 6/16:

8:30 CPI

8:30 Philly Fed Business Outlook

10:00 Housing Market Index

Friday 6/17:

8:30 Housing Starts

Mid-year financial update: What to do with your money now

The Federal Reserve has thrown a wrench into what was shaping up to be a very good six months for investors. Since you can’t do much about the timing of the Fed’s policies and the gyrations in the market, six months into the year is a perfect time to revisit the financial issues over which you actually have control: your investments, retirement savings and some of those other financial to-do’s that have been on your list for a while.  Investments: Quit complaining about the markets and DO SOMETHING. Remember that if you are a long-term investor, periodic market pullbacks are great opportunities to rebalance your accounts so that your allocation remains in check. This requires that you override your emotional urge to keep winning funds and dump those that are lagging. But that’s the point of asset allocation—various funds are supposed to move in different directions at different points in the economic cycle.

Bonds: Given the recent move in the bond markets, you may be tempted to sell all of your bonds. But of course that would be market timing and you are not going to fall for that, are you? Here are alternatives to a wholesale dismissal of the fixed income asset class:

• Lower your duration: This can be as easy as moving from a longer-term bond into a shorter one. Of course, when you go shorter, you will give up yield. It may be worth it for you to make a little less current income in exchange for diminished volatility in your portfolio.
• Use corporate bonds: Corporate bonds are less sensitive to interest-rate risk than government bonds. This does not mean that corporate bonds will avoid losses in a rising interest rate environment, but the declines are usually less than those for Treasuries.
• Explore floating rate notes: Floating rate loan funds invest in non-investment-grade bank loans whose coupons "float" based on the prevailing interest rate market, which allows them to reduce duration risk.
• Keep extra cash on hand: Cash, the ultimate fixed asset, can provide you with a unique opportunity in a rising interest rate market: the ability to purchase higher yielding securities on your own timetable.

Retirement: Many people say they are worried about retirement, but most of them haven’t done any planning to help themselves. Any conversation about retirement must start with an easy step: calculating  your retirement numbers. EBRI’s “Choose to Save Ballpark E$timate” (www.choosetosave.org/ballpark/) is easy to use, or check out your retirement plan/401(k) website for more retirement tools.

Homeowners and Renters insurance: It seems like the past year has seen an unusual number of natural disasters from tornados to hurricanes to wild fires. Summer often brings more scary weather, so before an event occurs; make sure that your current coverage is adequate. The three biggest mistakes that people make with their homeowners or renters insurance are: 1) under-insuring; 2) shopping for price only and not comparing apples to apples; and 3) not reading policy details before a loss occurs.

Estate Planning: If you haven’t done so already, PLEASE DRAFT A WILL! I advise hiring a lawyer to prepare a will, power of attorney and health care proxy/living will. If you insist on doing it yourself, you can use a software program like Quicken WillMaker. All of your estate documents and final instructions should be stored in a safe place – don’t forget to provide copies to your executor/trustee.

If your total estate is greater than $5.25 million this year, a revocable or changeable trust will shelter your unified tax credit against federal estate and gift taxes. Many states impose a state death tax at lower levels, so check the rules. Even if your estate is unlikely to incur estate taxes, you may want a trust to better control the disposition of your assets. Revocable trust assets are not subject to probate.

Volatile markets are always unsettling, but doing what you can now, may help you feel more in control and enjoy the second half of the year a little more.

Distributed by Tribune Media Services

Bonds away: How to protect against rising interest rates

When investors look back at the spring of 2013, they may say it was the moment when the bond market finally shifted and a new trend of higher interest rates emerged. It appears that the long-awaited reversal of the bond market has begun. In early May, the yield of the 10-year treasury hovered at just above 1.6 percent. While that wasn’t the all-time low (1.379 percent in July 2012), it was pretty close. We have all known that bond yields would have to rise, eventually. We’ve known that at some point the fear of the financial crisis would recede, the economic recovery would become self-sustaining and the Fed would stop purchasing bonds. Whenever that occurred, the 30-year bull market in bonds would come to an end, pushing down prices and increasing yields

Many bond market moves look benign in the rear view mirror, but they can feel pretty dramatic in real time. The rise in 10-year yields from 1.62 percent in the beginning of May to a 16-month high of 2.35 percent in mid-June might not seem like a big deal – just 0.73, right? But it’s important to realize that it’s a 45 percent move in just 6 weeks!

What does that kind of move mean to your portfolio? It means that many of your bond positions have lost value, because as interest rates rise, the price of bonds drops. The magnitude of your hit is partially tied to the duration of the holding. Duration risk measures the sensitivity of a bond’s price to a one percent change in interest rates.

The higher a bond’s (or a bond fund’s) duration, the greater its sensitivity to interest rate changes. This means that fluctuations in price, whether positive or negative, will be more pronounced. Short-term bonds generally have shorter durations and are less sensitive to movements in interest rates than longer-term bonds. The reason is that bonds with longer maturities are locked in at a lower rate for a longer period of time.

For those of you who own individual bonds, the price fluctuations that occur before your bonds reach maturity may be unnerving, but if you hold them to maturity, you can expect to receive the face value of the bond.

If you own a bond fund, it may be scary to see the net asset value (NAV) of the fund drop when rates increase. To soothe you a bit, remember that when NAV falls, the bonds within the fund should continue to make the stated interest payments. As the bonds within the fund mature or are sold, they can be replaced with higher-yielding bonds, which could create more income for you in the future. Additionally, if you are reinvesting interest and dividends back into the fund, you may benefit from purchasing shares at lower prices.

To help protect your portfolio against the eventual rise in interest rates, you may be tempted to sell all of your bonds. But of course that would be market timing and you are not going to fall for that, are you? Here are alternatives to a wholesale dismissal of the fixed income asset class:

Lower your duration: This can be as easy as moving from a longer-term bond into a shorter one. Of course, when you go shorter, you will give up yield. It may be worth it for you to make a little less current income in exchange for diminished volatility in your portfolio.

Use corporate bonds: Corporate bonds are less sensitive to interest-rate risk than government bonds. This does not mean that corporate bonds will avoid losses in a rising interest rate environment, but the declines are usually less than those for Treasuries.

Explore floating rate notes: Floating rate loan funds invest in non-investment-grade bank loans whose coupons "float" based on the prevailing interest rate market, which allows them to reduce duration risk.

Keep extra cash on hand: Cash, the ultimate fixed asset, can provide you with a unique opportunity in a rising interest rate market: the ability to purchase higher yielding securities on your own timetable.

So even if this truly is the turnaround in the bond market that we’ve all been waiting for, there’s no reason to be afraid. Just pay closer attention to your bond holdings, and know how to protect yourself from rising rates!

Distributed by Tribune Media Services