Still think the Federal Reserve will raise interest rates at its monetary policy meeting next week? Last Friday’s jobs report for May should make you rethink that notion. But it’s not the only reason.
Prior to the release of the report – which showed that the economy added just 138,000 jobs last month, nearly 50,000 below expectations, while the previous two months were revised downward by 66,000– the market consensus called for the Fed to raise rates by 25 basis points at its June 13-14 meeting. That doesn’t seem like such a sure thing anymore.
After its last meeting on May 2-3, when it took no action on rates largely because of a weaker-than-expected economy in the first quarter, the Fed said it expected the slowdown was “likely to be transitory.” Now, however, we have a pretty substantial body of evidence that indicate fairly strongly, if not consistently, that the slowdown has continued well into the second quarter.
The minutes of that meeting released two weeks ago, said, “Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the committee to take another step in removing some policy accommodation.” The initial market reaction to the minutes focused on the word “soon,” which was interpreted to mean “June,” maybe because they rhyme. It now looks like the word “if” is the most important word – as in, if the economy performs up to expectations. Unless the Fed is going to raise rates regardless of what’s going on in the economy, then the odds have swung towards no increase this month.
For months now the Fed has been telling us how “tight” labor conditions are, focusing mostly on the super-low 4.3% unemployment rate. But the accuracy of that figure leaves a lot to be desired, especially as it clashes with the labor participation rate – which fell again to 62.7% in May – and the fairly weak rise in average hourly earnings to 2.5% annual growth. Now the May jobs number shows that the market isn’t as tight as the Fed thinks.
Here’s an experiment for you: The next time you have a day off during the week, visit your local bank, supermarket, Walmart or Home Depot during the day and see the huge number of people about. Does that look to you like full employment? If all these people supposedly have jobs, why are they all shopping and banking during the day? The fact is that the jobless rate is grossly undercounting the real figure, and shouldn’t be trusted. The economy is still pretty weak, and way too many people are unemployed or underemployed.
The Fed’s own reports bear this out. Its most recent Beige Book, covering most of April and May, said that “a majority of districts reported that firms expressed positive near-term outlooks; however, optimism waned somewhat in a few districts.” Notably, “Boston and Chicago signaled that growth in their districts had slowed somewhat to a modest pace, while New York indicated that activity had flattened out.”
The Fed’s main measurement of inflation, the personal-consumption-expenditures price index, is flashing the same message. The index rose in April by just 1.7% on a yearly basis, down from the prior month’s 1.9% increase and further below the Fed’s 2% target rate for raising rates.
According to its prior statements this year, the Fed was basing a lot of its newfound optimism about the economy on the likelihood of President Trump getting his growth agenda of tax cuts, deregulation and health care and budgetary reform through Congress and enacted into law. Quite clearly, the probability of that happening anytime soon, never mind this year, seems fanciful at best.
The bond market is certainly signaling its doubt about a rate increase next week. Immediately after the May jobs report was released, the yield on the 10-year Treasury note dropped four basis points to below 2.17%, its lowest level since last
October, which hardly signals any imminent upward move on rates.
Of course, now that the Fed has given fairly bright signals that a rate move is likely “soon,” what happens if its carefully laid plans don’t materialize? What will be the stock market’s reaction if the Fed doesn’t raise rates, indicating a lack of confidence in the economy?
The S&P 500 is up 17% since Trump’s election and continues to rise. However, several sectors that were supposed to benefit the most from his victory have since sold off pretty dramatically when it started to appear that his economic agenda was running into trouble.
The KBW bank index jumped 40% between the end of last September and March 1 of this year. Since then, the index has dropped about 10%, while several major components, like Bank of America, are down by even more. Can we expect a similar correction in the overall market if the Fed offers a surprise next week?
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.