The Big Yawn About the Fed

Today is the market’s 7th anniversary of the 2009 stock index lows.

Until recently, the seven-year stock market rise depended on easy Fed policies. Less than a year ago, a report that the Fed was about to raise interest rates would send panic through the markets, but that no longer is the case.

Last week, Fed Chair Janet Yellen and other Federal Reserve officials made it clear that the Fed was almost certain to increase interest rates again at its March meeting. (The vote will be announced during the afternoon of March 15.) Yet, markets hardly reacted to the news.

From the financial crisis until near the end of 2016, there was great trepidation at every rumor or hint about a Fed rate increase. There was so much concern, the Fed delayed its 2016 rate increase until December after all but promising to raise rates several times in 2016.

Since Fed officials made clear that they’re very likely to raise rates at the next meeting, U.S. stock indexes lost less than 2%. The worst interpretation of the events is that the announcements about the Fed’s plans brought to a halt the strong rally in U.S. stocks. But those announcements didn’t trigger a correction.

Long-term bonds haven’t reacted as well, even though they are supposed to lose value when rates rise. In fact, long-term bonds had a strong counter-trend rally from the lows of December 2016.

The market reaction indicates that most analysts now agree that U.S. economic growth is self-sustaining and no longer relies on the Fed’s extraordinary measures.

The reaction also indicates that there’s less to worry about from the rest of the world. In 2015 and 2016, the Fed regularly indicated that it was delaying interest rate increases primarily because it feared higher rates would damage economies outside the United States and secondary effects of that damage would hurt the U.S. economy. Now, despite many problem situations around the globe, few worry that higher rates in the United States will damage other economies and markets or trigger a crisis.

We’re still a long way from normal interest rates. The rate increases we’re talking about are very modest.

It is possible that markets will react after the Fed raises rates and render my points here moot. That’s unlikely, since the rate increase is well telegraphed. It appears that investors are confident about the economy, at least for now.

The Data

The data continues to indicate the economy is growing, but there are some mixed signals about how strong that growth is.

In the non-manufacturing sector (about 80% of the economy), the widely followed ISM Non-Manufacturing Index indicated growth increased by rising to 57.6 from 56.5. That’s the highest reading since October 2015. The report was strong across the board, even for exports. The PMI Service Index, on the other hand, declined to 53.8 from 55.6. The ISM index generally is considered to be a broader assessment of the economy.

The manufacturing sector weakened again, according to Factory Orders. While the headline number of a 1.2% increase was good, when transportation is excluded, orders rose only 0.3%. Core capital goods, which reflect business spending on basic equipment, declined 0.1%. As we discussed last week, this is another example of how the hard data of economic activity aren’t keeping up with the optimism in the surveys and anecdotal reports, such as the Fed regional bank surveys.

Productivity remains sluggish. The second estimate of fourth quarter productivity held firm with a 1.3% increase. Output declined while hours worked increased, so it took more labor to produce less. Also, unit labor costs increased by 1.7%. The report indicates the fourth quarter was a tough one for business profit margins.

Employment has been the strongest part of the economy (it’s usually a lagging indicator), and the jobs reports leading into tomorrow’s headline-grabbing Employment Situation reports indicate it is likely to be strongly positive. New unemployment claims rose by 20,000 in the latest week, but that is from a record low level. The weekly and four-week numbers continue to be near record low levels.

The ADP Employment Report, which covers private sector jobs, reported a blockbuster 298,000 new jobs for the month and revised last month’s estimate higher to 261,000 from 246,000 jobs. This month’s number is the highest since October 2015 and one of the best since the financial crisis.

The Markets

The S&P 500 lost 1.34% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 1.14%. The Russell 2000 sank 3.18%. The All-Country World Index lost 1.25%. Emerging market equities declined 1.79%.

Long-term treasuries lost 1.41%. Investment-grade bonds declined 1.03%. Treasury Inflation-Protected Securities (TIPS) fell 0.80%, while high-yield bonds lost 1.89%.

The dollar rose 0.27%.

Energy-based commodities fell 3.24%, as broader-based commodities declined 1.80%. Gold dropped 2.51%.

Bob’s News & Updates

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