Crossing Wall Street Review – June 9, 2017
Get Ready for a Fed Rate Hike
By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (NYSE Arca: CWS)
On Tuesday and Wednesday of next week, the Federal Reserve gets together for another policy meeting. The two-day affair usually gets a lot of attention because it’s followed by a press conference from Fed Chairwoman Janet Yellen.
Much of Wall Street has this meeting circled on their calendars. They figure that if the Fed is going to strike, it’ll do it in June. At this two-day meeting, the Fed also updates its economic projections. These are more often referred to as “the blue dots” in honor of the Fed’s scatter plots.
Earlier this year, the consensus on the Fed was that it would raise interest rates three times this year plus three more times in 2018 and 2019. I thought this was nuts. I reassured readers that the Fed always starts out sounding as hawkish as it can but then gradually gives way. This time, it hasn’t.
During this cycle, the Fed first raised rates in December 2015. They followed that up with another raise in December 2016, and again in March 2017. Traders in the futures market think there’s a 93.5% chance that the Fed will hike next week. If they’re right, that would move the target for the Fed funds rates from 1% to 1.25%.
What about after that? Traders see the Fed standing pat for a few months. I think that’s right. But by the December meeting, another rate hike is in play. Right now, the odds are very nearly even money for a December hike.
I’ll briefly restate my opposition. The Fed should only move once there are signs that inflation is heating up. Those signs aren’t here yet. The commodity markets aren’t rallying. Oil has been falling lately. The latest CPI reports have been very tame. We’ll get the May CPI report on Wednesday, the morning of the Fed’s announcement.
Last week’s employment report was not terribly strong. The U.S. economy created just 138,000 net new jobs. Economists had been expecting 185,000. The numbers for March and April were revised lower. The growth in wages is actually decelerating slightly. The yearly growth number fell from 2.51% in April to 2.46% for May.
I don’t want to sound overly alarmist. There have been improvements in the economy. The last earnings season was quite decent. But as far as interest rates go, I think the Fed needs more time. I’m particularly concerned to see long-term interest fall. After the election, long-term yields soared on the prospects of greater economic growth. To be fair, yields at the long end had been rising since the summer.
We heard a lot about the Trump Trade, but that started to unravel in December. Three months ago, the 10-year Treasury was yielding over 2.6%. Lately, it’s gotten close to 2.1%. If the Fed follows through with its rate hike, the famous Two/Ten Spread will probably fall below 70 basis points. That would be a nine-year low. That’s still not in the danger zone, which is 0.00, but it’s getting close. The hidden story here is that the Fed’s “ceiling” for rate increases is probably a lot lower than folks want to admit.