Commentaries

PMC Weekly Review - June 19, 2015

At the Federal Open Market Committee meeting earlier this week, the Federal Reserve (Fed) signaled that it was poised to begin raising interest rates incrementally. Following nine years of rate reductions as status quo, market participants ostensibly could begin to breathe a sigh of relief.

A potential rate hike comes as a positive sign for the economy, because it means that for the first time in nearly a decade, the Fed is comfortable enough with the health of the economy to set a path forward toward monetary tightening. The size or pace of the increase itself is not as important as the direction of the trajectory, and ongoing quantitative easing in Europe and Japan will mean that the Fed has the leeway to do so in a gradual fashion. The last time the Fed raised rates was in June 2006, and the market has operated in a near zero interest rate environment since December 2008.

Following a contraction in first quarter data, economic indicators generally are improving – with a marked increase in consumer, employment, and housing data. Weekly jobless claims came in lower than expected on Thursday: 267,000, hovering near 15-year lows reached earlier in the quarter. Consumer spending, a critical component that drives GDP growth, is rising—demonstrating that consumers are showing increased confidence in improved housing conditions and a strengthening labor market even with higher oil prices. Employers added 280,000 jobs in May, and building permits, signaling homebuilder confidence, hit a new 8-year high despite an 11.1% decrease in housing starts.

Macroeconomic data aside, underlying market fundamentals also support our thesis of an improving economy: the Nasdaq hit an all-time high on the heels of a strong biotechnology sector, and IPO activity is resoundingly strong. The Nasdaq soared to an intraday record of 5,143 on Thursday, edging out its previous peak of 5,132 achieved more than 15-years ago, in March 2000, during the dot-com boom. Notably, the Russell 2000, favoring small caps over large cap stocks, also reached an intraday high this week. Yesterday’s successful public debut of Fitbit also reinforced investors’ appetite for growth, reinvigorating the IPO market which, hampered by low energy prices, had a soft beginning to the year. New US IPOs in 2014 were the highest since 2000, and second-half activity appears to be re-accelerating as 32 new deals are expected to price in June alone.

So, is the perceived rate hike set in stone? No, not exactly. Conceivably, scenarios like a Greek contagion or deceleration in US economic activity certainly could prompt regulators to shift course. However, the US has learned from Japan’s experience, and is finally lifting its foot off the gas pedal on accommodative monetary policy. As we are aware, quantitative easing is not sustainable, and central banks must raise rates to prevent deflation. So, whether the Fed decides to increase rates once or twice this year, we can see a gradual path toward rising US treasury rates and a strong US dollar.

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