PMC Weekly Review - May 20, 2016

A Macro View – Economic Soup

Minutes from the Federal Reserve’s (Fed) April Federal Open Market Committee (FOMC) meeting, released on Wednesday, reveal that the Fed is giving earnest consideration to increasing the federal funds rate as early as June.  The statement confounded markets following the Committee’s earlier move in March to cut its projected 1% hike for 2016 in half. The Dow dropped over 180 points immediately following the announcement, but ended the day nearly flat.

As Federal regulators contend with a range of financial data, both positive and negative, it would seem that they are positioning themselves for increased mobility in a scenario of varied economic outcomes. Several members opined that the market’s perception of a June hike was “unduly low,” and the meeting recap serves as a tool to convey this message and reframe expectations.

Positive indicators like a strengthening in housing and labor market conditions bode favorably for the economy. Housing starts increased from 1,099,000 to 1,172,000 this week, and building permits increased from 1,077,000 to 1,116,000. Initial jobless claims fell to 278,000 from 294,000 the week prior.  Consumer sentiment, at 95.8, is at its high for the year, and inflation is well below the 2% objective, helped in part by the sharp decline in energy prices earlier this year. Energy prices have since rebounded to more moderate levels in recent weeks, which in turn should serve to bolster earnings and buoy the stock market going into the second half; crude oil is currently trading at just below $50 a barrel, up from an intraday low of just under $27 a barrel in January 2016.

Conversely, negative signals, such as a weak first quarter earnings cycle and the decline in manufacturing, suggest a continued rut in the business cycle and corporate overhang.  The NY Empire State Manufacturing Index registered at -9.0 for May, as compared with 9.6 the previous month.  The Philadelphia Fed Manufacturing Index had a reading of -1.8 for May, as compared with -1.6 for April. Globally, many economies are struggling with deflation risk and negative interest rates, as is the case with Europe and Japan.  Additionally, others (like Brazil) are just starting to climb out of recessions, burdened by the weight of increased interest rates despite the forward-thinking measures of the central banks in the face of commodity declines. In addition, unrest continues in the Middle East, where terrorism is suspected in Thursday’s disappearance of an Egyptian Air flight carrying 66 passengers from Paris to Cairo, which conceivably poses an event risk.

On balance, indications are that the US will continue to edge forward. The FOMC has reassured us that “economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate,” and that the rate is “likely to remain, for some time, below levels that are expected to prevail in the longer run.” Recessionary fears over China have simply been overdone, and we do not have the same excesses in the financial system that contributed to the crisis in ’08—namely, the glut in housing, corporate leverage, and consumer debt. The environment continues to be supportive for income assets and single-digit equity returns.

All in all, it’s a hodgepodge of ingredients, and the Fed is rightly adopting a ‘wait and see’ approach – much like your grandmother’s famous kitchen sink soup, in which the only official ingredient is care. The measurements are never exactly the same, and the cook is constantly refining the product, often taking advantage of what’s in the refrigerator. Nonetheless, it proves to be satiating, and sustains us for another day.

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