Never Satisfied
The markets never seem to be satisfied.
The Federal Reserve recently took heed of market and economic messages,
ending its tightening campaign and beginning its “patience” campaign. The yield curve had begun to invert in early
March, 2019 in response to economic slowdown fears and a flight to quality began
where demand for US Treasury bonds increased, pushing longer-term rates
down. I along with countless other
managers and investors were finally happy.
Chairman Jerome Powell listened and stopped raising short-term
rates. The markets have always thought
that the Fed tightens to keep an overheating economy and inflation in check,
neither of which we have right now. The
Fed also announced that they would end the sales/runoff of their bond
portfolio, affectionately known as “QT,” or quantitative tightening. The markets hardly seemed satisfied with
these two moves as they began building in rate cuts. Rate cuts?
Who said anything about rate cuts?
But, what if rates are already too high?
The economy is slowing, as seen in the auto, housing, manufacturing, and
retail sectors. I’ve been watching the
balance of the economic data releases shift to “weaker” over the past two
months. Growth around the world is
slowing, too. Every major economy,
including the United States, European Union, China, Japan, Australia and New
Zealand, and Great Britain (with Brexit issues), is dealing with weaker growth.
Unemployment and Inflation
The Fed has to follow their dual mandate, which is to maximize
employment and maintain price stability.
The Fed kept raising short-term interest rates because they felt
unemployment under 4% was too low and would cause inflation (the traditional
Phillips curve theory). Yes,
unemployment is low. In fact, job
openings are over 7.1 million and exceed unemployed persons of 6.2
million. This has been the case for
about the past twelve months. The Fed
worried that wage pressures would escalate because of skills gaps. Yet, wages increases have been modest and did
not contribute to higher inflation. Consumer spending has weakened recently but is
expected to resume its modest pace for the year. High debt levels- consumer, business, and
government- continue to weigh on growth, which should be between 2.0% and 2.5%
this year.
Inflation remains well behaved, except for the March producer price
index data release, which showed an increase of a surprising +.6% for the
month. Oil and gasoline price increases
have caused this; oil has risen from $45 to $64 per barrel this year
alone. Before inflation bugs panic, one
release does not make a trend. Leading
inflation gauges show a declining year-over-year pace of inflation. The TIPS spread, or the difference between
the 10-year Treasury and the 10-year Treasury inflation-protected yields, has
fallen in recent months and is currently at 1.95%. The weaker economy is keeping inflation in
check. And gold prices rose this year
into February and March, but have fallen back to equal year-end 2018 levels
today.
Jamie Dimon
It is a not-so-well-kept secret that I admire Jamie Dimon, CEO of JPM
Chase, and have followed his career since the late 1990s. I admire his business savvy, his wealth of
knowledge about the economy and the financial markets, his ability to deal with
crisis, and his dedication to making people’s lives better through JP Morgan Chase
Bank community initiatives. His annual
shareholder letter, like Warren Buffett’s, is a must-read for investors. He touches so many subjects and isn’t afraid
to criticize government policies that are holding our economy back. Dimon believes that we will see weak GDP
growth this year. He warns that we could
soon see poor liquidity and declining investor sentiment that will add to
market volatility.
A Win for the Ages!
Did you have an opportunity to watch the Masters and witness Tiger Woods
win his fifth green jacket? He played
the final round methodically, strategically, and did not let developments
affect his play. He watched others take
the lead and then lose it…to him. Once
in the lead, he played to win. He showed
us that he can win despite the many setbacks he has endured, especially the
physical ones of the past few years. To
me and to millions of supporting fans, Tiger’s win was one for the ages! I will not forget that day!
The Outlook
I formulated my estimates for 2019 early this year and haven’t seen a
reason to change them. I estimated that
real GDP growth would be between 2.0% to 2.5% for the year, which is at a
slower pace than the +2.9% in 2018, but about equal to the average growth since
2011. I had assumed that the Fed would
not raise rates again. The impact of the
tax cuts has faded. Interest rates have
stabilized at lower levels, after falling dramatically since December, and the
yield curve is relatively flat, with only 13 basis points between the
three-month and 10-year Treasury yields.
The Federal Reserve made it clear that they would remain patient in
assessing the economy and that they would not be raising short-term interest
rates this year. They recognize that
growth is slowing here at home and around the world. They stated that they did not want to cause
an inverted yield curve and they meant it, as they realize that inverted curves
are recession precursors. I always
believed that Chairman Powell would read the markets correctly and do the right
thing. He knows that market volatility
has risen, the data has been weaker, and liquidity is reduced as M2 growth
declines. M2 growth is today at 4%,
which is nearly one-half of what it was three years ago. Yes, M2 matters.
Our current economic recovery is fast approaching a longevity record;
growth through July, 2019 would set the new record at 121 months, surpassing
the 1991 to 2011 recovery. Unemployment
is low at 3.8% in March, 2019 and inflation, as reflected in core personal
consumption expenditures, was +1.8% in the fourth quarter of 2018. I don’t expect much change in either of these
measures. Consumer spending has been
weak in recent months, but as job growth continues at a steady pace, we should
be able to see GDP growth of 2% or more.
However, don’t count on the usual spending boost from personal tax
refunds as they are down by over $6 billion from this time last year. And remember that the Fed stopped raising
rates, so that should aid growth.
While the guessing game has already begun about when the Fed will ease
or lower rates, I think growth will be steady (if you call the low 2%s steady)
enough to keep the Fed on the sidelines.
The markets seem to enjoy guessing what the future holds, especially
when it comes to Fed policy. I’m not
playing the game right now although I mentioned earlier that I think short-term
rates might be too high…
I finish writing this with a heavy heart. I am watching video of Cathedrale Notre-Dame
de Paris on fire. Prayers and thanks for reading! 04/15/19
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 Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, 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 of devotion.
