Federal Reserve: See you in December!

Nothing is certain, but it’s fair to say that it is highly unlikely that the Federal Reserve will raise interest rates when it meets this week. While various Fed officials have tried to keep the prospect of an increase on the table, a so-so August jobs report, weaker than expected retail sales and still soft manufacturing data combined to push the odds of a hike at below 20 percent, according to the futures market. That means the focus will turn to the Fed’s economic projections, which have been off the mark for most of the past year, and the accompanying statement. When Chair Janet Yellen spoke from Jackson, she noted that the case for a second interest rate increase was “strengthening”. That may be true, but it is clearly not strengthening enough to warrant a move now. Most analysts expect that the central bankers will send smoke signals that the December meeting is not just possible, but likely.

Of course, because this is the Fed, there will be nothing like this: “We can’t raise rates yet and certainly will not do anything in November, just days before the election, but clear your schedules for December 14^th, because we plan to celebrate the one-year anniversary of the first rate hike in a decade with another quarter point!” At this pace you might earn one percent on your savings account by the time the NEXT Olympics rolls around in 2018! To put into perspective just how slow this rate tightening cycle is, compare it to the most recent campaign in 2004-2006, when the central bank increased the fed funds rate by a quarter-point five times in 2004, eight times in 2005 and then four times in 2006.

Meanwhile now that Americans finally got a raise after eight years of stagnating incomes, maybe they will start spending with a little more gusto. In its 2015 Poverty and Income Report the Census Bureau said median (the point where half of households fall below and half are above) household income rose by 5.2 percent to $56,516. The good news is that the gains were seen in all regions, across all age groups, and for most ethnic and racial groups. BUT (you know there would be a catch!) even with the bounce, inflation adjusted income remains below the $57,423 in 2007, just before the Great Recession began and is still 2.4 percent less than the peak of $57,909, reached in 1999.

On a more positive note, with the gains in income, the split between workers and companies appears to be narrowing. According to Capital Economics, “At its peak in 2001, labor compensation accounted for 57.7 percent of GDP, but it subsequently fell sharply, hitting a 60-year low of 52.5 percent in the first quarter of 2012.” While labor’s share has been falling due to longer-term trends like structural factors such as globalization and the decline in the power of and membership in unions, the drop accelerated due to the weakness of the post-recession labor market. As the labor market has improved, especially over the past few years, labor’s share of income has started to rebound, “rising to 54.3 percent in the second quarter of this year” and those gains correspond to a drop in the corporate profit share.

MARKETS:

• DJIA: 18,123, up 0.2% on week, up 4% YTD
• S&P 500: 2139, up 0.5% on week, up 4.7% YTD
• NASDAQ: 5244, up 2.3% on week, up 4.7% YTD
• Russell 2000: 1224, up 0.5% on week, up 7.8% YTD
• 10-Year Treasury yield: 1.69% (from 1.68% week ago)
• British Pound/USD: 1.3002
• October Crude: $43.03
• December Gold:  at $1,310.20
• AAA Nat'l avg. for gallon of reg. gas: $2.19 (from $2.18 wk ago, $2.30 a year ago)

THE WEEK AHEAD:

Mon 9/19:

10:00 Housing Market Index

Tues 9/20:

FOMC Meeting Begins

8:30 Housing Starts

Wells Fargo CEO John Stumpf testifies before the Senate Banking Committee about the 2M unauthorized accounts the bank had opened.

Weds 9/21:

2:00 FOMC Meeting Announcement/Economic Forecasts

2:30 Fed Chair Press Conference

Thursday 9/22:

8:30 Chicago Fed National Activity Index

9:00 FHFA House Price Index

10:00 Existing Home Sales

10:00 Leading Indicators

Friday 9/23:

Yellen's Jackson Hole Speech May Move Markets

The first eight months of the year have been dominated by one question: When will the Fed raise rates next? The answer may come from a surprising place: Jackson Hole, WY. Since 1982, the Federal Reserve Bank of Kansas City has hosted a late summer economic policy symposium in Jackson Hole. The event brings together central bankers, private market participants, academics, policymakers and others to discuss the issues and challenges in a public but informal setting. While this may sound like a bunch of boring people in a beautiful location, in recent years, some central bankers have made big news from Jackson. In 2010, Fed Chair Ben Bernanke discussed the pros and cons of several policy options, including buying “longer-term securities,” which was the premise of the second round of quantitative easing or QE2. Two years later, Bernanke used his Jackson Hole remarks to introduce the possibility of a third round of asset purchases known as QE3, when he said: “The Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

Four years later, the central bank is no longer buying assets to prompt economic growth, but so far, it has only increased its benchmark interest rate one time-last December. While some Fed officials have recently been leaning towards an interest rate increase sooner rather than later, others are concerned that the economy remains too fragile to risk higher rates. Further evidence of the division between the two camps was evident in minutes from the last policy meeting.

That’s why at this year’s Jackson Hole confab, traders and economists will listen closely to current Fed Chair Janet Yellen’s speech, “The Federal Reserve’s Monetary Policy Toolkit” to see if there is either an implicit or explicit clue about when the next rate hike will occur. While she is not likely to say, “September is baked in the cake,” she may discuss the factors that would lead to an increase in September, like another strong employment report along with firming inflation. Right now, the market is predicting just a 20 percent chance of a September move and 50 percent likelihood at the December meeting. A September surprise could knock stocks down from their peaks and usher in what could be a bumpy autumn.

MARKETS: Summertime and the living is easy….in what was a typical August week, stocks bounced around all-time highs, but closed mostly unchanged amid light volume.

• DJIA: 18,552, down 0.1% on week, up 6.5% YTD
• S&P 500: 2183, down 0.01% on week, up 6.8% YTD
• NASDAQ: 5238, up 0.1% on week, up 4.6% YTD
• Russell 2000: 1236, up 0.5% on week, up 8.9% YTD
• 10-Year Treasury yield: 1.58%
• British Pound/USD: $1.3078
• September Crude: $48.52, up more than 20% since falling below $40 in early Aug
• August Gold:  at $1,340.40
• AAA Nat'l avg. for gallon of reg. gas: $2.16 (from $2.13 wk ago, $2.63 a year ago)

THE WEEK AHEAD:

Mon 8/22:

8:30 Chicago Fed National Activity Index

Tues 8/23:

10:00 New Home Sales

10:00 Richmond Fed Manufacturing Index

Weds 8/24:

9:00 AM FHFA House Price Index

9:45 PMI Manufacturing Index Flash

10:00 Existing Home Sales

Thursday 8/25:

First day of Kansas City Fed Econ Symposium in Jackson Hole, WY

8:30 Durable Goods Orders

11:00 Kansas City Fed Manufacturing Index

Friday 8/26:

8:30 GDP

8:30 International Trade in Goods

8:30 Corporate Profits

10:00 Janet Yellen’s speech from Jackson Hole

10:00 Consumer Sentiment

Greece, Jeb! and Stock Corrections

European leaders will convene yet another emergency meeting in Brussels on Monday to discuss how and whether to restructure Greece’s debt. This may all sound like déjà vu all over again, but contrary to five years ago when the Greek drama started to unfold, today investors are less concerned that a default would take down the euro zone or the interconnected global economy. It could however, create a bout of panic in the markets. If officials do not come to an agreement, they will have no choice but to come up with a Plan B, which would likely include capital controls to limit withdrawals from Greek banks and prevent a classic run on the banks (see “It’s a Wonderful Life” for the best explanation of a bank run). In fact, about €5 billion of deposits reportedly left Greek banks last week alone. Instead of a well-orchestrated Grexit, there could be what the FT’s John Authers calls a “Graccident”, where a default would lead to a messy and de facto Grexit. Plan B would also likely include the European Central Bank’s extension of emergency loans to Greek financial institutions and Greece’s preparation of a new currency or IOU system.

As the tragedy that is Greece continues, investors seem more interested in the Federal Reserve. Last week, Chair Janet Yellen elegantly threaded the needle: Yes, the central bank would most likely raise short-term interest rates this year (probably two quarter of a percent increments), but the pace of increases will be gradual. Complicating matters for the central bankers was the first quarter, when the economy contracted by 0.7 percent. Sure, most of the slowdown was due to transitory factors, like weather, the West Coast port shutdown and $40 crude oil, but far be it for this Fed to err on the side of snuffing out potential growth.

The government will provide a third update to Q1 GDP this week, which may show marginal improvement, but most have already set their sights on the rest of the year, which should improve steadily. Because Q1 was such a stinker, growth for the total year is likely to be 2.5 percent, matching the pace of the past few years.

I usually quote the post World War II rate of growth, which is about 3.3 percent, as a benchmark, but according to the New York Times that longer term average may overstate the expected growth rate today. The reason is that “Over the last 40 years, the American economy has grown at an average of 2.8 percent per year,” which is considerably slower than the 3.7 percent average from 1948 to 1975. Additionally, the higher rate includes “two favorable trends that are now over: women entering the work force, and baby boomers reaching their prime earning years.”

The downshift in growth expectations might come as a surprise to newly minted presidential candidate Jeb Bush, who in a speech last week said that his goal for economic growth was 4 percent. The Financial Times called this figure “Fantasyland” and the NYT chimed in, saying Mr. Bush’s 4 percent goal has “close to 0 Percent Chance” at success.

MARKETS: While the NASDAQ and Russell 2000 indexes were making new highs last week, two other indexes weren’t so fortunate. The Dow Jones Transportation Average entered correction territory (a drop of more than 10 percent) for the first time in nearly four years and the Shanghai Composite lost 13.3 percent for the week, the worst week since the financial crisis and the second time this year it has fallen into correction territory. Additionally, last week brought the biggest outflows from bond funds in two years, triggered by the possibility of not one, but two, interest rate hikes later this year. These events were just more fodder for those worried investors who are convinced that the next leg for the broad U.S. market is down.

• DJIA: 18,015, up 0.7% on week, up 1.1% YTD
• S&P 500: 2110, up 0.8% on week, up 2.5% YTD
• NASDAQ: 5,117 up 1.3% on week, up 8% YTD
• Russell 2000: 1284, up 1.6% on week, up 6.6% YTD
• 10-Year Treasury yield: 2.27% (from 2.39% a week ago)
• August Crude: $59.61, down 0.6% on week
• August Gold: $1201.90, up 1.9% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.80 (from $2.80 wk ago, $3.68 a year ago)

THE WEEK AHEAD:

Mon 6/22:

8:30 Chicago Fed

10:00 Existing Home Sales

Tues 6/23:

8:30 Durable Goods Orders

9:00 FHFA Home Price Index

10:00 New Home Sales

Weds 6/24:

8:30 Q1 GDP – final reading (prev = -0.7%)

Thurs 6/25:

8:30 Personal Income & Spending

Fri 6/26:

10:00 Consumer Sentiment

Stocks: Up, Incomes: Down

You can forgive the vast majority of Americans for not celebrating last week’s 28^th record high of the year for the S&P 500 index. Oh sure, people like to see retirement accounts rise in value, but there is a pervasive sense among workers that they are not getting ahead. In fact, just as the stock market completed its strongest week in four months, a new report from Sentier Research on income revealed that many continue to struggle. As of June, median income for all households, adjusted for inflation, was $53,891. Here's the good news: in the past three years, incomes are up 3.8 percent. The bad news is that in the five years since the recession ended, median income has fallen by 3.1 percent. That’s just one of the reasons that when Federal Reserve Chair Janet Yellen delivered her much-anticipated speech from Jackson Hole, WY, she said that “the unemployment rate has fallen considerably, and at a surprisingly rapid pace,” but “the labor market has yet to fully recover.”

How has it not recovered? Well, as of July, there were 3.2 million workers who have been unemployed for more than 26 weeks and still want a job. Although this is well below the peak of 6.7 million and the lowest level February 2009, it is still very high. Additionally, while the unemployment rate has dropped nearly 4 percentage points from its late 2009 peak to 6.2 percent in July, the broad unemployment rate (defined as the official rate, plus marginally attached workers; those who are neither working nor looking for work, but want a job and have looked for work recently; and people who are employed part time for economic reasons), stands at a lofty 12.2 percent.

And then of course there’s the problem of Americans’ eroding earning potential, highlighted by the Sentier report. But as Yellen noted, part of the problem is structural, meaning that some global economic changes that have put pressure on incomes are here to stay. Sentier found that median income, adjusted for inflation, is 5.9 percent below where it stood in the year 2000. The stunning fact that the average American is WORSE OFF than he or she was fourteen years ago seems to get short shrift in reporting on the recovery.

There are a few factors that have contributed to the longer term slide in incomes: (1) Globalization allowed companies to move operations overseas, where wages were cheaper than in the US; (2) Technological advancements eliminated the need for as many workers overall; and (3) Most public companies have been more concerned with boosting share prices than in paying workers.

In an effort not to end on such a downbeat note, it’s worth noting that economists believe that as the economy continues to improve, incomes will slowly rise. Unfortunately, that may be cold comfort to millions who are having a hard time meeting their daily obligations. As one radio listener recently said, “I like when my 401K goes up, but it doesn’t help me pay the utility bill!”

MARKETS: Just in time for the busy Labor Day weekend, oil and gas prices have dropped to near 6-month lows.

• DJIA: 17,001, up 2% on week, up 2.6% YTD
• S&P 500: 1988, up 1.7% on week, up 7.6% YTD
• NASDAQ: 4464, up 1.7% on week, up 8.7% YTD
• 10-Year Treasury yield: 2.41% (from 2.34% a week ago)
• October Crude Oil: $93.65, down 1.2% on week
• December Gold: $1280.20, down 1.9% on week
• AAA Nat'l average price for gallon of regular Gas: $3.44 (from $3.54 a year ago)

THE WEEK AHEAD:

Mon 8/25:

10:00 New Home Sales

10:30 Dallas Fed Survey

Tues 8/26:

8:30 Durable Goods Orders

9:00 Case-Schiller Home Price Index

10:00 Consumer Confidence

Weds 8/27

Thurs 8/28:

8:30 Weekly Jobless Claims

8:30 Q2 GDP – 2^nd estimate (Preliminary: 4%)

8:30 Corporate Profits

10:00 Pending Home Sales

Fri 8/29:

8:30 Personal Income and Spending

9:45 Chicago PMI

9:55 Consumer Sentiment

Déjà vu for Fannie, Freddie and Housing

A whiff of the surreal wafted across the wires last week, when recently installed FHFA Director Melvin Watt presented the 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac. (In his role at FHFA, Watt is the overseer of government-owned mortgage finance giants Fannie Mae and Freddie Mac, which required a government bailout of $188 billion in 2008.) Watt did a u-turn from previously announced plans to reduce the maximum loan amounts that are eligible for purchase by Fannie and Freddie and to require larger down payments on mortgages in certain types of Fannie and Freddie-backed mortgage securities. Those measures would have made it harder for many borrowers to qualify for the low rates offered by government-insured loans. Watt cited concerns that the changes could hurt the fragile housing recovery.

In just six months, the pendulum has swung from a desire to make Fannie and Freddie smaller—and to eventually phase them out—to focusing on reducing taxpayer risk without necessarily shrinking the companies’ size. Watt’s plan came amid the Senate Banking Committee’s vote on the Johnson-Crapo Fannie, Freddie reform bill, which would overhaul and eventually eliminate Fannie and Freddie by constructing a new market system in which private investors would take initial losses on mortgage securities that would carry government reinsurance.

The final vote was 13 to 9, which is a smaller margin than supporters wanted and dim its prospects for a vote by the full Senate, at least for this year. Even if the bill were to make it to a Senate floor vote and pass, both of which are in question, it would not likely pass the House. While Watt noted that the government’s control of Fannie and Freddie “should never be viewed as permanent or as a desirable end-state,” for the time being, they are here to stay.

Watt’s comments come on the heels of Janet Yellen’s recent Congressional testimony, where she warned lawmakers that the nation’s housing recovery may have stalled. There may be further information about the Fed’s analysis of the housing slowdown when the minutes from the last policy meeting are released this week.

What’s got Yellen and Watts worried? Here’s where things stand versus a year ago (through March):

• Existing Home Sales: -7.5%
• New Home Sales: -13%
• Mortgage rates: +1%

There will be fresh data on existing and new home sales at the end of this week, but even if those results show weakness, the comparison is to last year, when the market was sizzling. For those fretting over housing, there was some good news on housing starts last week, which jumped 13.2 percent in April to a seasonally adjusted annual rate of 1.07 million, the highest level since November 2013. Multi-family homes, which have become increasingly popular in the wake of the real estate crash, were behind most of the increase.

Despite the bumps along the way, the housing recovery was always expected to lag the general economic and stock market rebound because of the depth of the melt down and the inability to unload a physical asset like a home. That said, part of the decline in existing home sales is related to fewer distressed sales, which is good news; the ratio of house prices to disposable incomes is still well below its long-run average; and buying a home is more affordable than renting across much of the nation.

Additionally, economists believe that the impact from rising mortgage rates is mostly behind us, as 30-year rates have steadied at a range of 4.2 to 4.5 percent. While that rate is higher than last May’s 3.6 percent, it is still a historically low level. And it has gotten a little bit easier to qualify for a home loan. Recent data from Ellie Mae show that the average FICO credit score on newly approved mortgages for home purchase was 725 in March, down from 750 a year ago, though still above the average American’s score of 690.

Even if the housing slowdown were to persist, its impact on the overall economy is much less than it used to be. Despite an uptick in the last two years, housing activity remains a smaller share of GDP since WWII. Residential investment accounted for 3.1 percent of GDP in March 2013, nearly half the level at the height of the housing bubble in 2006 and well below the 5 percent seen during much of the past few decades.

Of course both Yellen and Watt know all of this, which is why it was curious that both seemed to put the housing recovery on watch. A slowdown is not a meltdown and chances are, housing should continue to heal from the boom and bust.

MARKETS: On Tuesday, the Dow and the S&P 500 closed at new all-time highs. In the subsequent two sessions, investors took profits and the Dow and S&P 500 turned lower on the week. On Thursday, the Russell 2000 index of small stocks fell into correction territory, down more than 10 percent from its March 4th record closing high. The Dow and S&P 500 haven’t suffered a correction since the second half of 2011. The NASDAQ’s last 10 percent drop occurred in November 2012, although the tech-heavy index fell as much as 9.2 percent from early March through mid-April this year before bouncing back.

• DJIA: 16,491, down 0.6% on week, down 0.5% YTD
• S&P 500: 1877, down 1 point on week, up 1.6% YTD
• NASDAQ: 4,090, up 0.5% on week, down 2% YTD
• 10-Year Treasury yield: 2.52% (from 2.59% a week ago)
• June Crude Oil: $102.02, up 2% on week
• June Gold: $1293.40, down 1.2% on week
• AAA Nat'l average price for gallon of regular Gas: $3.65 (from $3.60 a year ago)

THE WEEK AHEAD:

Mon 5/19:

Campbell Soup, Urban Outfitters

Tues 5/20:

Salesforce.com, Home Depot, Staples

Weds 5/21:

Target, Tiffany

2:00 FOMC Minutes

Janet Yellen delivers commencement speech at NYU

Thurs 5/22:

Hewlett-Packard, Gap, Dollar Tree

8:30 Weekly Jobless Claims

10:00 Existing Home Sales

10:00 Leading Indicators

Fri 5/23:

10:00 New Home Sales

Fed Transcripts: Economists can be funny too!

Wouldn’t you hate it if you were to come upon a transcript of what you said, as you navigated a difficult time in your life? Now imagine what it would be like if that transcript was released publicly -- chances are, you would wish you could rewrite history. Alas and alack, without the ability to go back in time, you would be stuck with your mate or your dear friend saying, “Well, you did the best you could during a rough patch.” Those thoughts went through my head as I poured over the 2008 FOMC transcripts and then read all of the second-guessing by the financial press and various pundits. The bottom line is that not only was the Fed slow to realize the gathering storm in 2007 (In May 2007, Ben Bernanke said “We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system”), but when the once-in-a-generation storm made landfall in 2008, the Fed was caught flat-footed and “behind the curve,” according to Chairman Bernanke in January 2008.

For much of the spring and summer, some Fed officials thought the worst was over. In August, St Louis Fed President James Bullard said, “My sense is that the level of systemic risk associated with financial turmoil has fallen dramatically” and even Janet Yellen, who was prescient about the severity of the crisis earlier in the year and predicted recession before the NBER declared it so, momentarily took her eyes off the ball and worried unnecessarily about inflation.

OK, but that’s really cherry-picking the worst quotes from the year. (For the record, it appears that Boston Fed President Eric Rosengren may have been the most spot-on with his analysis of the crisis.)  In the last third of the year, circumstances demanded swift and decisive action and Fed officials rose to the occasion by slashing interest rates, buying bonds and implementing a variety of strategies to prop up the US and global economies.

Spoiler alert: The best part of reading through the transcript was to discover that some central bankers actually have a sense of humor. Frederick Mishkin invoked Monty Python’s “Look on the Bright Side of Life,” Donald Kohn quipped “Anyone who thinks he or she understands what’s going on is either a lot smarter than I am or delusional — or both” and Janet Yellen provided a bit of Halloween humor during an October meeting, when she said: “We have had a witch’s brew of news. Sorry. The downward trajectory of economic data has been hair-raising — with employment, consumer sentiment, spending and orders for capital goods, and home building all contracting — and conditions in financial and credit markets have taken a ghastly turn for the worse.”

HAHAHAHAHAHA…those crazy Fed officials!

MARKETS: The quiet, holiday-shortened week was highlighted by two technology sector deals: the maker of Candy Crush Saga is going public and Facebook is paying $19 billion for WhatsApp.

• DJIA: 16,103, down 0.3% on week, down 2.9% YTD
• S&P 500: 1836, down 0.1% on week, down 0.7% YTD
• NASDAQ: 4263, up 0.5% on week, up 2.1% YTD
• 10-Year Treasury yield: 2.73% (from 2.75% a week ago)
• Apr Crude Oil: $102.20, up 2% on week
• April Gold: 1323.60, up 0.4% on week
• AAA Nat'l average price for gallon of regular Gas: $3.40 (from $3.78 a year ago)

THE WEEK AHEAD: As we enter the third year of the housing recovery, two reports on real estate prices are expected to confirm that increases are slowing down from last year’s brisk pace. But the old saying “location, location, location” may still hold. According to HSH.com, housing affordability varies dramatically across the country. For instance, you need an annual salary of about $20,000 to afford a median home in Cleveland, but you have to earn a whopping $115,000 if you are seeking a median-priced home in the San Francisco area.

Mon 2/24:

8:30 Chicago Fed National Activity Index

10:30 Dallas Fed Mfg Survey

Tues 2/25:

Home Depot, Macy’s, T-Mobile

9:00 Case Schiller Home Price Index

9:00 FHFA Home Price Index

10:00 Consumer Confidence

Weds 2/26:

JC Penney, Target

10:00 New Home Sales

Thurs 2/27:

Best Buy, Kohls, Sears

8:30 Weekly Jobless Claims

8:30 Durable Goods Orders

10:00 Fed Chair Janet Yellen testifies before the Senate Banking Committee

Fri 2/28:

Berkshire Hathaway

8:30 Q4 GDP – 2^nd estimate (1^st estimate=3.2%)

9:45 Chicago PMI

9:55 U Michigan Sentiment Index

10:00 Pending Home Sales