Broker Check


May 18, 2015- What's Going On With the Economy and Interest Rates

| May 19, 2015
Share |

Months of tepid economic data and flirtation with higher interest rates lead many to ask

What's going on with the economy, and how will it affect the Federal Reserve's interest rate decision?
The Fed, which has kept interest rates low to help the economy out of the 2008 financial crisis, needs to start returning to "normal" monetary policy to keep inflation in check and to prevent too-low interest rates from spurring another asset bubble. However, raising rates too soon could derail the economic recovery, so the Fed is being quite cautious.[3] The Fed has emphasized flexibility in its approach to raising rates, which doesn't give us much of an idea of when they will raise rates. Right now, the consensus among economists is that the first rate hike will come in September, though it's not at all certain.[4]

Let's take a look at a couple of major indicators that give us a brief snapshot of the economy right now:

The latest jobs data shows that the labor market is improving. The economy added 223,000 new jobs in April, and the number of underemployed Americans is dropping.[5] Another recent report shows that the number of workers voluntarily quitting their jobs has hit its highest point since 2008 as Americans gain confidence in new opportunities.[6]

In the first quarter, economic growth flat lined, increasing just 0.2%, due to a combination of factors.[7] However, many economists expect the economy to shake off some of its headwinds and pick up this quarter.

Corporate profits in the first quarter were up a respectable 2.4% for S&P 500 companies (as of May 15, 2015), though revenues were down 3.7%.[8]However, companies have all lowered their expectations for the second quarter, indicating that they're still worried about domestic and global demand.

All of these indicators paint a picture of an economy that's still chugging along without showing the breakout growth we had hoped for this year. Though a recession doesn't seem likely, there are a number of global headwinds that may continue to dog the economy: volatile oil prices, a Chinese slowdown, and tepid consumer spending.

What would the Fed like to see before raising rates?
Recent statements from the Fed indicate that it is still in wait-and-see mode. Waiting to see what? A solid, sustainable turnaround in economic growth that's supported by the labor market. The deceleration of economic growth in the first quarter and a lack of wage growth gave the Fed pause for thought, and economists will want to see sustainable improvements in indicators like durable goods orders, business investment, and GDP growth before making their next policy move.[9]

What does this mean for investors?
Bottom line: We can expect markets to remain choppy as investors take stock of current conditions and try to determine where markets are going. Overall, we're cautiously optimistic about market performance. However, we recognize that persistent market highs in the face of mediocre data could set the stage for a short-term pullback. As always, we're keeping an eye on conditions and will let you know when anything changes.

ECONOMIC CALENDAR: 
Monday: Housing Market Index
Tuesday: Housing Starts
Wednesday: EIA Petroleum Status Report, FOMC Minutes
Thursday: Jobless Claims, Philadelphia Fed Business Outlook Survey, Existing Home Sales
Friday: Consumer Price Index, PMI Manufacturing Index Flash, Janet Yellen Speaks 1:00 PM ET 

Gray


Notes: All index returns exclude reinvested dividends, and the 5-year and 10-year returns are annualized. Sources: Yahoo! Finance and Treasury.gov. International performance is represented by the MSCI EAFE Index. Corporate bond performance is represented by the DJCBP. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.

HEADLINES:

Weekly unemployment claims fell unexpectedly. The most recent weekly jobs report showed that layoffs are dropping and new unemployment claims are close to the 15-year lows reached several weeks ago.[10]

Retail sales unchanged from March. Though March numbers were revised upward, April retail sales data was flat as Americans cut back on big-ticket purchases like televisions and autos. Economists had hoped that Americans would spend - rather than save - the money they pocketed from cheaper gasoline.[11]

China is America's largest creditor (again). Though central banks around the world have decreased their holdings of U.S. Treasuries, China's central bank is back on top with $1.261 trillion. Central banks hold foreign currency reserves mainly to cushion currency exchange rate shocks and keep rates steady.[12]

Mortgage applications fall as rates rise. A sharp rise in interest rates last week caused a drop in mortgage applications for both buyers and refinancers. Though mortgage volume is still up 14% from the same time last year, volume is shrinking as homebuyers balk at higher rates.[13]

Share |