Where Do We Go From Here?

As expected, the Federal Reserve left interest rates unchanged at last week’s post-Election Day monetary policy meeting, while signaling another 25-basis point increase in the federal funds rate at its December 18-19 get-together.

But the results of last week’s elections, which returned control of the House to the Democrats, may put future rate increases next year in doubt. That bodes well for long-term Treasury bond prices – i.e., yields may have peaked.

As we know, Maxine Waters, D-California, is now the likely next chairman of the House Financial Services Committee. To put it mildly, she doesn’t like banks. Her first order of business, no doubt, is to impeach President Trump, as she’s said countless times. But a more realistic second goal will be to roll back all or most of the recent bank regulatory measures made so far by the Trump Administration, which, of course, rolled back much of the regulatory measures passed under the previous administration, mainly through the Dodd-Frank financial reform law.

If she’s successful, that will reduce the mammoth profits the banks have been making the past several years, which were boosted further by the Republicans’ tax reform law. That sharply reduced corporate income tax rates, not just for banks but all companies, although the banks seem to be the biggest beneficiaries. No doubt Waters and her Democrat colleagues have that in their gunsights also.

But that won’t be the end of it. Continue reading "Where Do We Go From Here?"

Are We Better Off Today Than Two Years Ago?

Two weeks from now Americans will head to the polls to vote in what has been billed as “the most important election of our lifetime.” That may be a bit of hyperbole, but it will no doubt be one of the most important – maybe not as important as the previous one in 2016, but certainly a close second.

Since then, there have been some huge changes in the financial markets and the economy, nearly all of them wildly – and demonstrably – positive. CNBC was nice enough to quantify them the other day in this chart, and the numbers are startling.

I’ll just mention a few:

  • S&P 500: Up 32% since the 2016 election.
  • Average hourly earnings: Up 5%, to $27.24 from $25.88.
  • Nonfarm payrolls: up 4.4 million, to 149.5 million from 145.1 million.
  • Unemployment rate: 3.7%, down from 4.9%.
  • Consumer confidence: up 37 points, to 138 from 101.
  • Corporate tax rate: 21%, down from 35%.
  • Assets held by the Federal Reserve: down 6%, to $4.22 trillion from $4.52 trillion.

Needless to say, there have been some negatives: Continue reading "Are We Better Off Today Than Two Years Ago?"

Financials – Conspicuously Underperforming

Underperforming Despite Tailwinds

The financial cohort has conspicuously underperformed the broader market for the majority of 2018. The group didn’t participate in the broader market performance in Q3 where the S&P 500 had its best quarter since 2013. Banks have had domestic and global economic expansion tailwinds at its back while posting accelerating revenue growth, increasing dividend payouts, engaging in a record number of share buybacks and benefiting from tax reform. Augmenting this economic backdrop is a record number of IPOs, a record number of global merger and acquisitions, rising interest rates, deregulation, and tax reform. Banks are benefiting in unique ways due to the consulting fees regarding mergers and acquisitions and trading around market volatility. All of these elements provide an ideal confluence that bodes well for the financial sector. JP Morgan (JPM), Citi (C), Wells Fargo (WFC), Goldman Sachs (GS) and Bank of America (BAC) seemed to be poised to continue to benefit from the favorable economic backdrop. Thus far in 2018 the financials have performed terribly considering the broader market performance and the aforementioned economic tailwinds. There’s negative sentiment that’s placed the financials in a holding pattern for much of 2018 over concerns of rapid interest rate increases and an inverted yield curve.

The Federal Reserve, Rising Interest Rates and Economic Strength

The Federal Reserve expects the economy to continue to strengthen and inflation to rise shortly. The economic strength coupled with the threat of inflation provides an environment that’s ripe for rising interest rates. The Federal Reserve has been very bullish on the domestic front and signaled that rate hikes will continue and may even accelerate its pace of rate hikes contingent on inflation and economic strength. There’s no question that the financials benefit from rising interest rates, and Bank of America(BAC) has one of the largest deposit bases among all banks and serves as a pure play on rising interest rates. Goldman Sachs (GS) has even branched out into consumer banking with its Marcus product so needless to say all big banks will benefit from their deposit bases.

Federal Reserve Chairman Jerome Powell stated that the unemployment rate currently stands at 3.9%, near a 50-year low while core inflation is right around 2%. Powell said that these two metrics are part of a “very good” economy that boasts “a remarkably positive outlook” from forecasters. The central bank approved a quarter point hike rate in the funds rate that now stands at 2.25%, and the committee indicated that another rate hike would happen before the end of the year. 2019 will likely see three more rate hikes and 2020 will see one rate hike before pausing to assess the delicate balance of rising rates in the midst of a strong economy while taming inflation. Continue reading "Financials – Conspicuously Underperforming"

Onward And Upward

Apparently, the bond market just got the email that the U.S. economy is smoking and that interest rates are going up.

The yield on the benchmark 10-year Treasury note jumped 17 basis points last week to close at 3.23%, its highest level since March 2011. The yield on the 30-year bond, the longest maturity in the government portfolio, closed at 3.41%, up an even 20 bps.

The pertinent questions are, what took so long to get there, and where are yields headed next?

Analysts and traders pointed to the Institute for Supply Management’s nonmanufacturing index, which rose another three points in September to a new record high of 61.6. The group’s manufacturing barometer, which covers a smaller slice of the economy, fell 1.5 points to 59.8, but that was coming off August’s 14-year high.

Bond yields jumped further after the ADP national employment report showed private payrolls growing by 67,000 in September to 230,000, about 50,000 more than forecast. It turns out the ADP report didn’t precursor the Labor Department’s September employment report, but it was still pretty strong. Nonfarm payrolls grew weaker than expected 134,000, less than half of August’s total of 270,000, but that number was upwardly revised sharply from the original count of 201,000, while the July total was also raised to 165,000. The relatively low September figure was blamed not on a weakening economy but on the fact that employers are having trouble finding workers. Meanwhile, the unemployment rate fell to 3.7% from 3.9%, the lowest rate since December 1969.

Indeed, last week’s jobs report only confirmed Continue reading "Onward And Upward"

What's The Right 'Neutral' Interest Rate?

Will last Friday’s August jobs report showing that wages rose nearly 3% compared to a year ago finally convince the Federal Reserve that inflation really is starting to pick up steam? If not, what exactly will it take?

That report was certainly good news for workers, who have waited a long time – since 2009, apparently – to see their wages rise by so much. But it also provides convincing evidence that 2% inflation – which the Fed has been trying to stoke for the past 10 years – has finally arrived. But will the Fed actually believe it and do something before it “overheats,” to use its word?

A hike in the federal funds rate to 2.25% at the Fed’s September 25-26 monetary policy seems like it’s already baked in the cake. But it’s still not a given that another one will happen at the December meeting. According to CME’s Market Watch tool, the odds of a rate hike at the yearend confab are only 72%, compared to more than 98% for this month’s meeting. (While the Fed does meet in early November – just a day after the “most important election in our nation’s history,” if you believe some of the political pundits – a rate change then is very unlikely. The Fed has indicated that it will only adjust rates at a meeting that ends with a press conference by the Fed chair. That pretty much disqualifies November).

After the jobs report was released, the yield on the two-year Treasury note hit 2.70%, its highest level in more than 10 years. The benchmark 10-year note closed last week at 2.94%, its highest point in over a month. That those rates didn’t go even higher seems to indicate that the market isn’t yet sold on two more rate increases this year.

At least one member of the Fed is. Continue reading "What's The Right 'Neutral' Interest Rate?"