What’s Up With The Economy and Interest Rates?

Fed stays in wait-and-see mode

Weekly market view from LMK Wealth Management. Reprinted with permission.

 

Markets ended Friday on a high note with the S&P 500 setting a new record though economic data was lukewarm.

For the week, the S&P 500 gained 0.31%, the Dow grew 0.45%, and the NASDAQ rose 0.89%. 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. 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.

All about the jobs

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.

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. In the first quarter, economic growth flat lined, increasing just 0.2%, due to a combination of factors.

However, raising rates too soon could derail the economic recovery, so the Fed is being quite cautious

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%.

Still chugging, though slowly

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.[

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