Looking Ahead to May Events
By: Tim McPartland,
So here we are heading into May tomorrow and we wanted to take a quick look at the May “events” that could be critical drivers of income portfolios during the month.
Starting on Tuesday, May 2nd, we have the Federal Open Market Committee (FOMC) meeting. Of course these meetings are always important, but this year they will be of the greatest importance that we have really seen in the last 5 years. The importance is because the FED starting their interest rate tightening cycle in earnest in December 2016 with a 1/4% rate hike and then followed that up with a rate increase in March, 2017. We now have a Fed Funds target of 3/4% to 1%.
So with the meeting starting on Tuesday there is always a chance that a rate hike could be announced on Wednesday when the meeting concludes. We rate the odds of a hike on Wednesday as ZERO. After the pathetic GDP announcement last Friday–1st quarter GDP at .7%, it would make no sense whatsoever, to any sane person, to push short term rates higher. Certainly GDP is only one of many pieces of data that the FED watches closely, but it is important. The other most critical data that the FED is watching is employment and inflation. These are “the” items that will make a difference in the interest rate path that the FED will take on the Fed Funds rate. It is critical that it is understood that the Fed Funds rate is a very short term interest rate–typically overnight. While investors seem to believe that this very short term rate drives long term interest rates (10 year to 30 year rates) we have seen recently that these longer term interest rates are purely market driven. Shortly after the Fed increased short term rates in March the 10 year treasury hit a yield of 2.6%, but rates have moved persistently lower ever since hitting 2.16% 2 weeks ago. Some discussion of a tapering of quantitative easing a couple of weeks ago spooked the 10 year rate back up to 2.3% in the last week.
Let’s look at what we think is the most important item likely to potentially cause a crash of sorts to the income securities marketplace. Sure something like a surprise interest rate hike by the Fed of 1/2% would most certainly cause a panic, but the item that we think is mose likely to cause an uncalled for panic would be quantitative tightening–the reversal of present Fed policy. The FED started quantitative easing with a balance sheet of $900 billion and that has now grown to over $4 trillion. With maturities of Fed holdings occurring at a approximate rate of $40 billion per month even if the Fed started letting the maturities “roll off” the balance sheet it would take 7 years to get back where we started at years ago–yikes!! Worse yet the Bank of Japan, the European Central Bank and the U.S. Fed have over $13 trillion worth of assets they have accumulated during the various QE programs–it would seem to me that the odds that this whole issue will be resolved over the next 10 years (or more) is extremely remote. We believe that the Fed may try to “taper” some of the maturing assets as early as June and that the amount they let go to maturity without reinvestment of the proceeds could be in the $5-$10 billion range. While at this pace it will literally take forever to run off the balance sheet it is not so important that the balance sheet return to prior levels it is only important to move in the right direction and we have said since last year that the removal of QE is as important as returning the Fed Funds rate to normal levels and the only reason to be concerned with either is simply to get ready for the next recession–so there is dry powder to fight the recession with lower rates and stimulus. On the other hand it is important to not cause the next recession by raising rates too much, too soon—a tightrope walk it is for sure.
So back to May data. On Friday of the coming week the employment report will be released. Honestly we are skeptical of the accuracy of this number–but it is what it is and as long as the Fed is paying attention to it we have to do the same. The report from April showed a shockingly low job creation number of 98,000 which was about 50% of the consensus number. The consensus for April to be released Friday is 185,000. This is a critical number to watch to help determine whether the Fed will move rates higher in June. Will it be a “blowout” number to compensate for last months poor results or will it be another disappointment. Who knows?
Now in addition to the above most important data we have potential for geopolitical events that will drive markets into a panic. What will happen with China relative to North Korea and what will be the reaction of the President to another nuclear bomb test in North Korea? Does it matter? We learned long ago that worrying about geopolitical events and investing based on personal worries is a losing game-you can’t sell out and crawl in a hole.
Investors should continue to invest and should realize that the short term information (data) may make a difference in how much “dry powder” you keep on hand, but generally you have to be invested and that is what we plan to be doing.