Two brutally cold winters in a row!
By this time, we have all had enough of the cold, the polar vortex, the
snow, the freezing rain, the ice, and the potholes that are left on our
roadways to harass and frustrate us. At
least we are not in Boston. We need a
change of seasons!
2015 ushered in a whole new season of volatility in the bond and stock
markets. Stocks have seen a large number
of trading days with price changes greater than 1% and coincidentally, the Dow
and SandP averages are up year-to-date by about 1%. Longer term interest rates have moved by
large amounts in short periods of time.
Witness the 10 year Treasury note- its yield dropped by 0.50% in January to
1.68%, rose by 0.33% in February to 2.01%, rose to a short term high of 2.21% on
March 9th and dropped back to 1.94% for the end of March. Investment decisions and timing are unusually
difficult. US bonds are also whipsawed
every time a geopolitical event rocks the newswires, such as growing Middle
East conflicts, ISIS fighting, and the Russia-Ukraine situation.
Speaking of the change in seasons, the Federal Reserve seems determined
to begin their own season of change by raising interest rates. Some Fed officials want to raise rates
regardless, saying rates are just too low with an unemployment rate of 5.5% and
should be returned to “normal.” It has
been nine years since the Fed last tightened policy in June, 2006; maybe they
are getting anxious. However, some
officials, including Chair Janet Yellen, want to keep letting the economy and
the data lead them to raise rates if necessary, but to keep rates low if
necessary, too. Just last week, Chair
Yellen addressed the slow GDP growth that we have experienced for the past six
years of our so-called recovery, which has been anything but “normal.” She acknowledged studies that suggest that
future GDP growth will also be painfully slow due to changing demographics and
low productivity.
This slow growth, despite the low 5.5% unemployment rate, would cause
the Fed to keep rates at the current low levels for an extended time
period. The studies suggest stagnation
much the same as what Japan has experienced in the past twenty years, where
zero interest rates and central bank easing campaigns failed to stimulate
growth. Here in the US, short term rates
have been at zero since December, 2008 and countless rounds of forward guidance
and trillions of dollars of bonds bought by the Fed in QE programs have failed
to push our growth rate much above +2.0%.
In 2014, our GDP growth was +2.4%; in the fourth quarter, it was +2.2%
with real final sales rising only a measly +0.1%. The so-called recovery that began in June,
2009 has produced growth rates only about one half of “normal” recoveries since
WWII.
Oil Steals the Show
The biggest story of the past year in the markets has to be the plunging
price of oil, down 50% in 2014 to below $50 per barrel. The US has led the world in energy and oil
production from its shale and fracking operations. Suddenly, the extent of excess supply became
apparent. Weak demand for oil from
struggling economies in China, Japan, Russia, and Europe, almost assures
continued excess supply in 2015. Falling
oil prices, and falling gasoline prices, are like a welcome tax cut for
consumers who are saddled with low wage growth and lack of good jobs. Many people, including myself, thought that
the drop in gas prices would lead to higher consumer spending, perhaps even
more than the amount they save when filling their gas tanks, but this has not
been the case. Spending has been weak
since December and the savings rate has risen to 5.8%, which is the highest
since December, 2012. Energy companies
moved to cut production and investment to align to the new $50 per barrel
reality and, in the process, would cut jobs.
Since the US is now a larger producer of energy in the world markets,
the effects are being felt here at home as well as in OPEC countries and Russia.
Stock market volatility began after the plunge in oil prices, as fear of
the effects on energy companies emerged.
Bonds recognized something else- the reality of falling inflation- and
the prospects that inflation is expected to be lower in the next several
years. Year-over-year CPI was flat in
February, 2015; there has been only one year-over-year decline since 1955 and
that happened at the height of the financial crisis in 2008. This brings me back to the Fed- slow growth,
low inflation- is that a recipe for raising interest rates? I think not.
But if they do raise rates, they will control short term rates. Long term rates will still be driven by
inflationary expectations and should stay low.
Will the Fed manipulate long term rates by selling some of their accumulated
$4 trillion of QE bonds?
Strong Dollar
While we weren’t looking, the US dollar strengthened by 20% in the past
year. This strengthening is cited as one
of the factors that contributed to falling oil prices, since oil is usually
denominated in US dollars. A strong
dollar serves to ultimately hurt our exports, and thus our GDP growth, while
keeping imports attractive and import prices low. This is another factor that will be
considered by the Fed; a strong dollar will support lower interest rates as
demand for US securities increases relative to the bonds of other nations.
So will the Fed raise rates in 2015?
Only they know for sure. I try
not to make bold predictions anymore, because just when you think you can throw
a one yard touchdown pass, some guy comes out of nowhere and intercepts
it. Many of the Fed officials keep
saying rates should be increased because they want to raise them. Maybe they will; maybe they won’t. But I do believe that, if they do, they will
be lowering them a few meetings later.
The economic growth we have is too slow and is perhaps unsustainable,
wage growth is low, inflation is even lower, and the dollar is strong. When I enter those key inputs into my
formulas, the result is lower rates, not higher ones. Maybe Janet Yellen’s own words from her
speech last week tell it all: “The tightening
pace could speed up, slow down, pause, or reverse.” If you know what she is going to do, let me
know! Stay tuned!
Thanks for reading! 03/30/15
Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004. She is the author of Just Another Good Soldier, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure.
