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Get ready for the first Fed rate hike of 2018. Newly minted Fed Chair Jerome Powell will preside over this week’s two-day meeting, where officials will also release their updated economic projections and future rate hikes. Analysts at Capital Economics believe that Fed “consensus is shifting from three to four rate hikes this year.”
The May jobs report was a stinker. The economy added just 38,000 jobs, the fewest since September 2010. Even adding back the 37,000 jobs lost in the telecom sector, which was primarily due to the recent Verizon strike, May was a dismal month for hiring. Adding to the downbeat news, revisions of March and April reduced jobs by 59,000, pushing down average monthly job creation for 2016 to 150,000, well behind the more than 200,000 thousand gains seen over the past few years. Although the year-over-year change in May was an impressive 2.39 million jobs, the recent trend is worrisome: Over the past 3 months, job gains have averaged 116,000 per month. Additionally, the unemployment rate fell to 4.7 percent, the lowest level since November 2007, but that was due to more people dropping out of the workforce, not because a slew of wannabe employees got jobs. Unfortunately, the weakness was widespread. Manufacturing lost 10,000 jobs, construction shed 15,000 jobs and temporary help fell by 21,000.
Despite recent comments by Fed officials extolling the improvement in the economy, the weakness in this report likely means that the central bank will not raise rates when it meets in a week and a half. It also calls into question the health of the overall recovery in the second quarter, which is estimated to accelerate by about 2.1 - 2.3 percent on an annualized basis.
In the first quarter, we could attribute the paltry 0.8 percent GDP to plunging oil prices, a stronger U.S. dollar and weakness in China. But those factors have largely turned around: crude has soared from $27 per barrel to nearly $50; the dollar has stabilized after rising sharply against other major currencies in late 2014 and early 2015; and although Chinese growth remains on the worry list, there has been a simmering down of tensions.
The economic expansion celebrates its seventh birthday this month, making it the fourth longest recovery since World War II. Although the recovery has been sluggish—GDP has averaged just over two percent a year, the labor market has shown more impressive progress, until recently. Whether or not this is the beginning of the end for the robust gains in job creation is unknown at this point. What’s seems knowable is that the Fed is not going to raise rates amid the current environment.
Last week, Fed Chair Janet Yellen said that the central bank would likely to raise interest rates “gradually and cautiously” because raising them too quickly could trigger a downturn to which the Fed may have limited tools to respond. Given this report, it would seem that caution would be appropriate at the June meeting.
MARKETS:
THE WEEK AHEAD:
Mon 6/6:
Janet Yellen speaks
Tues 6/7:
8:30 Productivity and Costs
3:00 Consumer Credit
Weds 6/8:
10:00 Job Openings and Labor Turnover Survey (JOLTS)
Thursday 6/9:
Friday 6/10:
10:00 Consumer Sentiment
2:00 Treasury Budget
“I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy.” - Federal Reserve Chair Janet Yellen, July 2015
This week, the central bank will do something that it has not done in over nine years: raise short-term interest rates. With the economy growing at a decent, though not great 2.25 percent annualized pace, 2015 monthly job creation averaging 210,000 and unemployment sitting at a seven-year low of 5 percent, Yellen and her cohorts have reiterated that now is the time to normalize policy.
This will be the first of many Fed actions that will eventually return rates to somewhere in the vicinity of 3.5 percent. How quickly they get there is up for discussion. Today the bond futures market anticipates that it will take around three years, but Yellen has said that the future path of interest rates will be entirely data dependent. If inflation rears its head, hikes may be quicker than the expected pace of every other meeting for the next three years. If the economy stalls, the central bank could pull back and skip a meeting.
Considering that it rates have been sitting at zero for seven years, it is helpful to review where we were then and where we are now. Though Americans may complain about slow growth, how quickly we forget what rotten looks like.
December 2008:
December 2015:
HOW WILL THE FED’S ACTIONS IMPACT INVESTORS?
Another big difference between where we are today versus seven years ago is that the Fed will be increasing rates with a balance sheet that has more than quadrupled through three rounds of bond buying (quantitative easing). How various markets will react to the first hike is unknown, because of the very fact that we are entering unchartered and choppy water.
Stocks: Typically, stock markets have dipped after the first rate increase, but usually regain their upward momentum, as long as the rate increase is in response to stronger economic activity. Stocks usually top out after the final increase. The last tightening cycle began with interest rates at 1 percent in June 2004 and ended with rates at 5.25 percent two years later. The stock market peaked in October 2007 and you know what happened after that!
Emerging markets are already feeling the effects, as investors exit risky bets in once high-flying markets like Southeast Asia, Brazil or Turkey. At the same time, US stocks are feeling the weight of sliding corporate profits. And while continued improvements in the economy and the slow pace of rate hikes could help equities regain more solid footing, many investors have forgotten how low interest rates made their stocks look attractive, relative to bonds.
Bonds: Billions of dollars have flowed into global bond markets over the past seven years, as nervous investors sought the safety of fixed income. Many investors are now fearful that rising interest rates will destroy the value of their bond positions. While it is true that as interest rates increase, prices on bonds that have already been issued, drops, that is not a good reason to abandon the asset class.
For most investors who own individual bonds, they will hold on until the bonds mature and then purchase new issues at cheaper prices/higher rates. For those who own bond mutual funds, they will reinvest dividends at lower prices and as the bonds in the portfolio mature, the managers will reinvest in new, cheaper issues with higher interest rates. In other words, being a long term investor should help you weather rising interest rates, though you may want to consider lowering your duration, using corporate bonds and keeping extra cash on hand. (For more on bonds, check out this post.)
HOW WILL THE FED’S ACTIONS IMPACT CONSUMERS?
In the seven years since financial crisis, companies, governments and consumers have gotten used to ultra-low interest rates. Here’s how the change in policy could impact you:
Savers: Any increase in the Fed Funds rate will help nudge up rates on savings accounts, so savers will finally be rewarded. That said, rates will still be low and the likely slow pace of increases will mean that savers’ suffering is not likely to end any time soon.
Borrowers: While rates for mortgages key off the 10-year government bond, adjustable rates are linked to shorter-term rates, which means that consumers should be careful about assuming these loans and also should consider locking in a fixed rate now. Additionally, as rates increase, the availability of 0 percent credit card and auto loans could diminish.
MARKETS: Oil, oil everywhere…and nobody wants to stop producing. Crude oil saw its worse week of the year, as evidence continues to mount that supplies are expanding amid withering demand.
THE WEEK AHEAD: All Fed, all the time…
Mon 12/14:
Tues 12/15:
Fed begins two-day policy meeting
8:30 CPI
8:30 Empire State Manufacturing Index
10:00 Housing Market Index
Weds 12/16:
8:30 Housing Starts
9:15 Industrial Production
2:00 Fed rate decision/Economic projections
2:30 Yellen Presser
Thursday 12/17:
8:30 Philadelphia Fed Survey
Friday 12/18:
