Monthly Archives: April 2017

Employment Situation, March 2017

April 7, 2017 By in employment, Employment Situation report, Federal Reserve, interest rates, Uncategorized Tags: , , , , Leave a comment

The Bureau of Labor Statistics released its monthly Employment Situation report earlier this morning.

With an addition of +98,000 jobs, the figures were a little more than half the rate of gain or recent months.  Revisions to data from the prior two months clipped another -38,000 positions from the total.

Although the report isn’t great reading for stock market bulls, we’ve seen over the past eight years of economic recovery that bad months occasionally occur, even in the midst of a sharply upsloping trend.  In addition, although the monthly figures are seasonally adjusted, the weather during 1Q17 has been so unusual in the populated regions of the US–unusually mild in January-February, ugly in March–that the first two months probably look better than they should and March worse.

The only really eyebrow-raising aspect of this report, in my view, is that despite the unemployment rate being at a very low 4.5%, there is still no sign of acceleration in wages.  This implies no urgency for the Fed to raise interest rates aggressively.

reversing quantitative easing

April 6, 2017 By in Federal Reserve, interest rates, Uncategorized Tags: , , , , , , Leave a comment

US stocks were up by about 1% yesterday when the minutes of the last Fed meeting came out.  As Fed watchers saw the topic of paring down the Fed’s $4 trillion+ holdings of government bonds was mentioned, stocks (but not bonds) began to give back their gains and ultimately finished the day lower.

What’s this about?

  1.  The Fed typically uses the Federal Funds rate for overnight loan to loosen or tighten money policy.  In doing so, it depends on the banking system to broadcast increases or declines in interest rates into the market for longer-term debt.  The problem since 2008 is that the banks had destroyed their own creditworthiness through years of unsavory and unsuccessful speculative financial markets trading.  So they were ineffective in performing this crucial rate-determining role.  Congress and the administration were–and still remain–lost in their inside-the-Beltway alternative universe, so there was no hope of help for the failing economy from that source.  The Fed’s solution was to begin “unconventional” operations, by buying huge amounts of longer-dated government debt in order to push down long-term interest rates itself.  It now holds something like $4.3 trillion worth of Treasury and government agency debt.
  2. The Fed has long since stopped making new net purchases of longer-dated bonds.  But as its existing bonds mature, it has continued to roll over the money it gets from them into new bond purchases.  The next step for the Fed in normalizing the long-term debt market will be to stop this rollover.  The consensus is that this change will happen later this year or early next.
  3. What’s “new” from yesterday is that the Fed put this thought down in writing, without specifying any details.

My take:  while the Fed announcement may have been the trigger for an intra-day selloff in stocks, the Fed minutes are not a big deal.  There is an investment issue as to how the Fed will proceed, but that will ultimately be influenced by how capable Mr. Trump will be to get Washington working again.

The President’s early performance has had two consequences:  US investors are beginning to think about shifting money to Europe.  Despite Brexit, that region is beginning to experience its own economic growth.  As well, it is having deep second thoughts about electing Trump-like figures in their own countries (we’ll learn more in the first round of the French elections on April 23rd), thereby increasing their attractiveness as an investment destination.

the Fed’s inflation target: 2% or 3%?

April 5, 2017 By in Federal Reserve, inflation, interest rates, negative interest rates, Strategy, Uncategorized Tags: , , , , Leave a comment

There seems to me to be increasing questioning recently among professional economists about whether the Fed’s official inflation target of 2% is a good thing or whether the target should be changed to, say, 3%.

The 2% number has been a canon of academic thought in macroeconomics for a long time.  But the practical issue has become whether 2% inflation and zero are meaningfully different.  Critics of 2% point out that governments around the world haven’t been able to stabilize inflation at that level.  Rather, inflation seems to want to dive either to zero or into the minus column once it gets down that low, with all the macro problems that entails.  It’s also proving exceptionally hard to get the needle moving in the upward direction from t sub-2% starting point.  My sense is that the 3% view is gaining significant momentum because of current central bank struggles.

This is not the totally wonkish topic it sounds like at first.  A 2% inflation target or 3% actually makes a lot of difference for us as stock market investors:

–If the target is 3%, Fed interest rate hikes will happen more slowly than Wall Street is now expecting.

–At the same time, the end point for normalization of rates–having cash instruments provide at least protection from inflation–is 100 basis points higher, which would be another minus for bonds (other than inflation-adjusted ones) during the normalization process.

–Over long periods of time, stocks have tended to deliver annual returns of inflation + 6%.  If inflation is 2%, nominal returns are 8% yearly; at 3% inflation, returns are 9%.  In the first case, your money doubles in 9 years, in the second, 8 years.  This doesn’t sound like much, either, although over three decades the higher rate of compounding produces a third more nominal dollars.

Yes, the real returns are the same.

But the point is that the pain of holding fixed income instruments that have negative real yields is greater with even modestly higher inflation than with lower.  So in a 3% inflation world, investors will likely be more prone to favor equities over bonds than in a 2% one.

–Inflation is a rise in prices in general.  In a 3% world, there’s more room for differentiation between winners and losers.  That’s good for you and me as stock pickers.