The Fed Finally Moves

Last update on: Oct 24 2019

The Fed finally pulled the trigger on another interest rate hike after a year of hand-wringing, fretting and promises.

The Fed also promised three increases in 2017. Of course, a year ago, the Fed announced it expected to increase the interest rate another four times in 2016.

The new policy and pronouncements are the result of upwardly revised economic forecasts by Fed officials. They see the economy as much stronger than they did back in September.

Much of the change is due to the election and the response of markets to the result. It also is due to the increase in optimism registered in a number of surveys of consumers and businesses.

The change puts the biggest risk of the last seven years back on the table. The greatest risk to markets and the economy is that the Fed raises rates too far, too fast. I don’t think that’s a big risk now, because the markets pushed rates higher before the Fed did. But, as in the last few years, we need to watch the Fed to be sure it doesn’t raise rates faster than the markets expect going forward.

We said back in the summer that inflation and interest rates would rise faster than most investors and the Fed were expecting. That’s why we sold long-term bonds and utility stocks. It also is why we’re more diversified and cautious than many investors are.

It is worth taking a deeper look at changes in the markets since the election. Much analysis has focused on the headline changes, but the details are more interesting. For example, the new highs in the stock indexes aren’t bringing all stocks upward with them. Financial stocks have been the leaders by a wide range, with Goldman Sachs spearheading them.

Banks and other financial firms are expected to benefit from higher interest rates and reduced regulation. Commodity and resource companies also have done well amid expectations that new fiscal policy will increase growth and inflation. Subtract financial and resource companies, and the indexes are up only about 1.5% since the election.

While initial action after the election focused on positive factors for the economy (lower taxes, increased infrastructure spending and reduced regulation), the focus has changed in the last week or so. Some observers point out that it will take time to implement the new policies, and they might be modified or watered down. In addition, the positive factors are likely to be at least partly offset by higher interest rates, a stronger dollar and higher commodity prices.

It always is dangerous to invest with a widely held consensus, and that’s what we’ve had the last month or so. Any change from the consensus will move markets quite a bit. As we move from speculation about the new administration to actual results, there’s likely to be less of a consensus. Things are going to be more uncertain and volatile going forward.

The Data

Consumers continue to be optimistic. Consumer Sentiment, as measured by the University of Michigan, soared more than four points to 98.0. That’s one-tenth of a point below the highest level of the recovery, which was reached in early 2015.

Small business owners also are feeling good, as measured by the NFIB Small Business Optimism Index. It rose 3.5 points to 98.4. That’s the highest level since May 2015 and puts the index just above its 42-year average. That’s significant, because the index has exceeded that average only three times since 2007.

Retail sales for the month didn’t reflect the optimism and rose only 0.1%. Auto sales had a 0.5% decline. Exclude them and sales increased 0.2%. That’s still tepid, but not as bad. Retail sales are volatile month to month, so it’s important to look at multi-month trends. The report had strong increases the previous two months, so an off month isn’t unexpected.

Industrial Production was disappointing, with a 0.4% decline. That was largely due to a sharp drop in utility output because of unseasonably warm weather in many areas. But the manufacturing component also was down 0.1%.

But there was better news on manufacturing from the first two regional surveys of the month. The Philadelphia Fed Business Outlook Survey registered a significant increase to 21.5 from 7.6 last month. Likewise, the Empire State Manufacturing Survey increased to 9.0 from 1.5. The Philadelphia survey has been fairly strong the last few months, while the New York survey has been weaker. This month’s number marks the first two months of consecutive positive index readings since June and July, compared to five consecutive positive months for the Philadelphia survey.

Also, the PMI Manufacturing Index mid-month flash increased 0.3 to 54.2. That also indicates growth is increasing in manufacturing.

Home builders are very optimistic. The Housing Market Index rose seven points to 70. That’s a new high for the recovery. The weakest part of the index has been traffic. But that even surged in this report to 53, putting it above 50 for the first time in 11 years.

Inflation continues to pick up. The Producer Price Index rose 0.4% for the month, giving it a 1.3% 12-month increase. Subtract food and energy and it is up 0.4% and 1.6%, respectively. Services are rising far faster than goods prices.

The Consumer Price Index also is rising. It was up 0.2% for the month and 1.7% for 12 months. Excluding food and energy, it is up 0.2% for the month and 2.1% for 12 months.

New unemployment claims declined another 4,000. The four-week average is just under 258,000.

The Markets

Stocks were rolling along with another strong week until the Fed raised rates. The S&P 500 rose 0.57% for the week ended with Wednesday’s close. The Dow Jones Industrial Average, which continues to be propelled by Goldman Sachs, rose 1.36%. The Russell 2000, which had been the leader in the rally, lost 0.55% for the week. The All-Country World Index lost 0.08%. Emerging market equities lost 2.62%, mostly due to declines in Asian equities.

Long-term bonds continued to tumble, losing 2.97% for the week. Investment-grade bonds declined 1.30%. Treasury Inflation-Protected Securities (TIPS) slid 1.39%. High-yield bonds lost 0.61%.

The dollar continued its surge, rising 1.81%.

Energy-based commodities rose another 0.99%. They’re now up 10.36% for the last four weeks. Broad-based commodities lost 0.04%. Gold continued to tumble, losing another 2.57% for the week.

Bob’s News & Updates

You might like my latest book, the revised edition of “The New Rules of Retirement.” Many other people have.

I’ll be making some speaking appearances in 2017. The first will be at the MoneyShow Orlando, February 8-11 at the Omni Orlando Resort at ChampionsGate. Use my priority code, 042315, and mention it when you call 1-800-970-4355 to register.

Some Reading for You

My blog has moved. Now you can find it on the Retirement Watch web site here.

There’s been a big shift in the most expensive ZIP codes as Silicon Valley prices take a break.

Negative interest rates in Europe could end in 2017, according to economists over there.

The demographics of the U.S. work force are improving after a few decades of deterioration.

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