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

Last Economic Blast for Summer

Here’s the good news: there is only one more important week of economic data left before Labor Day weekend -- the last blast for summer occurs this week. The bad news is that given the geopolitical events transpiring recently, the economy may eventually be the least of our problems. That said, investors have continued to take the various global conflicts in stride -- maybe a full week on the economic calendar will get them going. They'll need to shore up their energy before shutting down for August. The fun starts with the government’s first estimate of second quarter growth. After a horrible first quarter, where the economy contracted by 2.9 percent, Gross Domestic Product is expected to show an acceleration to an annualized pace of 3 to 3.5 percent. The rallying cry for the economy is quickly shifting from “2014: The year that growth returned to the US” to “2014: Here’s hoping that second half growth will save us!”

The sluggish first half growth will be front and center for the Federal Reserve, which will conduct a two-day policy meeting this week. It is widely expected that the central bank will announce another $10 billion cut to its bond-buying program, reducing monthly purchases to $25 billion. Officials are also expected to keep short-term interest rates near zero, where they have been since the height of the financial crisis in late 2008. Because there will be no press conference or Fed projections at this meeting, investors will pay close attention to the accompanying statement, which will highlight the Fed’s view on recent economic improvement and accordingly, when the central bank might raise short term interest rates (estimates are for some time in the first half of next year).

Fed Chair Janet Yellen has made clear that her perceptions of a healthy economy hinge largely on a healthy labor market. This week will also feature the July jobs report, which is expected to show continued progress. In the first half of the year, the economy has created an average of 231,000 jobs per month, putting it on track to add more jobs this year than any year since 1999. Economists predict that 225,000 jobs were created in July and that the unemployment rate will remain at 6.1 percent, the lowest level since September 2008.

Of course the labor market is more than just the unemployment rate or the number of jobs created. Whenever I write about the labor market, I receive a bunch of comments that say something like: “Sure the economy is adding jobs, but they are crappy, low-paying jobs!”  Indeed, job creation during the sluggish recovery has been skewed more towards lower wage industries, like hospitality and retail.

But the tide may be turning, according to the folks at Capital Economics, who note “the overall quality of the jobs being created is rising. Based on the mix of jobs added in each sector and the average weekly earnings within those sectors, our calculations suggest that the 1.3 million private sector jobs created in the first six months of this year paid an average of $867 a week. That’s slightly higher than the average of $843 per week that the existing 117 million private sector workers earn. The upshot is that the jobs created this year, have been of a slightly higher quality [than last year].”

Given that wage growth has been stuck at about two percent a year, just about matching the pace of inflation, it is no wonder that consumer spending has been spotty during the recovery. It is imperative to see an increase in take home pay for the average American worker, if we have any hope for a new, faster pace of economic growth to take hold in the second half of the year, and beyond.

MARKETS: Despite Friday’s sell-off on disappointing results from Amazon and Visa, earnings season has generally been better than expected. With nearly half of the S&P 500 having reported, 76 percent have beaten earnings expectations and 67 percent have reported above sales estimates, according to FactSet. Earnings growth for Q2 is growing by 6.7 percent, which is ahead of expectations for 4.9 percent growth as of June 30th. The telecom services sector is reporting the highest earnings growth for the quarter, while the Financials sector is reporting the lowest earnings growth.

• DJIA: 16,960, down 0.8% on week, up 2.3% YTD
• S&P 500: 1978, unchanged on week, up 7% YTD
• NASDAQ: 4,449, up 0.4% on week, up 6.5% YTD
• 10-Year Treasury yield: 2.47% (from 2.48% a week ago)
• September Crude Oil: $102.09
• August Gold: $1303.30
• AAA Nat'l average price for gallon of regular Gas: $3.53 (from $3.65 a year ago)

THE WEEK AHEAD: In addition to the highlights mentioned above, the week ahead will feature reports on housing prices, monthly automobile sales, personal income and spending, manufacturing and consumer confidence.

Mon 7/28:

Coach, Herbalife

10:00 Pending Home Sales

10:30 Dallas Fed Activity report

Tues 7/29:

American Express, Pfizer, UPS, Twitter

9:00 Case Shiller home price index

10:00 Consumer Confidence

Federal Open Market Committee begins

Weds 7/30:

Kraft, MetLife, Whole Foods

8:15 ADP Private Jobs Report

8:30 Q2 GDP (1^st estimate)

Federal Open Market Committee concludes

Thurs 7/31:

Avon, MasterCard, ExxonMobil, Conoco

8:30 Weekly Jobless Claims

10:00 Chicago PMI

Senate panel discusses results of a report on "too big to fail" banks (remember that?)

Fri 8/1:

Chevron, Clorox

Automobile Sales

8:30 July Employment Report

8:30 Personal Income and Spending

9:45 PMI Manufacturing

9:55 Consumer Sentiment

10:00 ISM Manufacturing

10:00 Construction Spending

Janet Yellen’s Eight Words

That was quite an initiation for Janet Yellen. After delivering mostly-expected policy decisions (a further $10 billion reduction in bond buying and the addition of new, more qualitative measures to determine when the central would raise short-term interest rates), the newly minted Fed Chair conducted her first press conference. Stock and bond markets were already trading lower before the presser began, in response to Fed officials’ raising interest rate projections slightly—by the end of 2015, it is now expected that the fed funds rate would be 1 percent, up from the 0.75 percent projection made last December, and by the end of the following year, the rate would be 2.25 percent, up from 1.75 percent. Those may not seem like big increases, but they represent a sizable jump, when it comes to market expectations. Yellen tried to downplay the increases, warning against reading too much into the so-called "dot plot," (the prediction of the Fed Funds rate from each Fed Governor is plotted on a chart).

But the change in rate expectations was just a warm up for the larger jolt to markets. The accelerant to the selling came later during the press conference, when Yellen was asked how long after the end of bond buying might the central bank start raising rates. In an offhanded manor, she responded with eight words that shook up markets: “something on the order of around six months.”

SELL MORTIMER, SELL! Investors quickly did a little math: if bond buying ends in the fall, that means interest rates could rise in the spring of 2015, about 3 to 6 months earlier than generally anticipated. Those words pushed up rate expectations and walloped stock and bond prices within moments that Yellen uttered them.

It took investors all of 24 hours to realize that maybe not much had changed after all. The Fed’s path is dependent on incoming economic data and both the Fed statement and Yellen’s press conference indicated that the central bank is likely to move only gradually. Unless inflation starts rising precipitously, the Fed will continue to err on the side of easy monetary policy.

It also is interesting to note that the central bank is notoriously bad at making short-term predictions about the economy and even if they are right about rates raising a sooner than previously thought, wouldn’t that be good news? It would mean that the economy had improved enough to warrant the Fed’s removal of stimulus. That may not be great news for fast money investors, but for everyone else in the real word, an economy that is growing by more than 3 percent annually, which can create decent jobs and where all income levels can get a raise, sounds dreamy.

A word about those elusive wage increases. There have been some murmurs about wage growth finally accelerating this year. Currently wages are increasing by about 2 percent from a year ago, but only by 1.1 percent after adjusting for inflation. But wage growth has been concentrated on the upper end of the income spectrum, according to the OECD’s Society at a Glance report, a data-driven barometer of the economic and social health of its 34 member countries. The report found that in the US, the share of pre-tax income going to the top 1 percent of earners continues to be the highest among OECD countries, standing at 19.3 percent in 2012, more than double the level in 1980.

As noted in House of Debt, real income for the median U.S. family doubled from 1947 to 1980, when the rising tide of productivity lifted all boats. However, “while the United States is producing twice as much per hour of work today compared to 1980, a small part of the gain in real income has gone to the bottom half of the income distribution,” as the share of profits has risen faster than wages and the highest paid workers are getting a bigger share of the wages that go to labor.

MARKETS: Despite the mid-week, Fed-induced sell-off, stock indexes finished higher over the five trading sessions.

• DJIA: 16,302, up 1.5% on week, down 1.6% YTD
• S&P 500: 1866, up 1.4% on week, up 1% YTD
• NASDAQ: 4276, up 0.7% on week, up 2.4% YTD
• 10-Year Treasury yield: 2.75% (from 2.65% a week ago)
• April Crude Oil: $99.46, up 0.9% on week
• April Gold: 1336, down 3.1% on week
• AAA Nat'l average price for gallon of regular Gas: $3.52 (from $3.69 a year ago)

THE WEEK AHEAD: As the second half of monthly housing data is released (new home sales and the Case Shiller price index), the biggest risk facing the market is that higher mortgage rates and tight credit conditions will sideline first time homebuyers. In order for the next leg of the housing recovery to take hold, these buyers must take the place of investors and cash buyers, who are likely to peter out.

Mon 3/24:

8:30 Chicago Fed National Activity Index

Tues 3/25:

9:00 Case-Schiller Home Price Index

10:00 Consumer Confidence

10:00 New Home Sales

Weds 3/26:

8:30 Durable Goods Orders

Thurs 3/27:

8:30 Weekly Jobless Claims

8:30 Q4 GDP (final estimate)

8:30 Corporate Profits

10:00 Pending Home Sales

Fri 3/28:

8:30 Personal Income and Spending

9:55 Consumer Sentiment