After a brief rally after the Federal Reserve announced its historic decision, markets ended another choppy week in the red, battered by plummeting oil prices and rocky investor sentiment. For the week, the S&P 500 lost 0.34%, the Dow dropped 0.79%, and the NASDAQ fell 0.21%.[i]
If you’re one of the millions of Americans who have better ways of spending time than watching the Federal Reserve, you may be wondering what will happen now that the Fed has voted to raise interest rates last week for the first time since 2006.[ii]
In her remarks, Fed Chair Janet Yellen said that the Fed believes that the recovery has come a long way and that the economy is ready for a “modest increase” in interest rates.[iii] The chart below will help put the rate increase in perspective:
Source: Federal Reserve Economic Data. Daily Effective Federal Funds Rate
After years of historically low rates, the Fed voted to raise rate targets by just a fraction of a percent. Though we don’t have definitive information about the pace of future rate increases, experts believe that the Fed is likely to raise rates several more times in 2016 and 2017, always assuming the economy remains on track for growth.[iv] Even if the Fed continues to raise rates regularly, it will take years to get back to historically average rates.
We can expect the coming weeks to be volatile for both stocks and bonds as investors adjust to the new rate environment. Historically, markets have experienced volatility after rate increases and occasionally moved into correction territory (defined as pullbacks of 10% or more). However, stocks and bonds usually experience positive returns in the initial years after the Fed begins tightening policy.[v] That being said, the past doesn’t predict the future, and we’ll be closely monitoring markets in the weeks and months to come.
Bottom line: The Fed rate raise is not necessarily a bad thing. The hike underscores the fact that the U.S. economy has made tremendous progress in the last 7 years. However, the raise also comes at a time when millions of Americans are underemployed, inflation is still below targets, and global headwinds are blowing in the face of U.S. firms. Realistically, there was never going to be a perfect time to raise rates, and it’s clear that the Fed is planning to take a gradual approach to future hikes.
Can the economy maintain its pace of growth without the Fed’s foot on the accelerator? We’ll see.
Tuesday: GDP, Existing Home Sales
Wednesday: Durable Goods Orders, Personal Income and Outlays, New Home Sales, Consumer Sentiment, EIA Petroleum Status Report
Thursday: Jobless Claims
Housing starts increase sharply. Groundbreaking on new construction rebounded from a seven-month low and jumped 10.5% last month. Permits for new buildings also surged to a multi-month high, highlighting strength in the housing market.[vi]
Weekly jobless claims fall. The number of Americans filing new claims for unemployment benefits dropped last week from a five-month high, suggesting that the labor market continues to improve.[vii]
Inflation remains stable. A measure of inflation – the general increase in the cost of goods and services in the U.S. – remained flat in November. However, core prices that exclude volatile food and fuel increased by 0.2%, indicating that inflation is firming up.[viii]
Industrial production drops in November. Warm weather and other factors drove the industrial sector of the economy lower by 0.6% last month. Though seasonal factors are affecting the data, lower global demand is making the effects more severe.[ix]
Markets ended a volatile week sharply down after oil hit near-seven-year lows and a major corporate merger highlighted global growth woes. For the week, the S&P 500 fell 3.79%, the Dow dropped 3.26%, and the NASDAQ lost 4.06%.[i]
Worries about the global economy took center stage last week as oil prices skidded to multi-year lows on warning of a supply glut. U.S. crude oil futures dropped over 10% lower for the week on expectations that oil prices may suffer from declining demand, high production volume, and a warm weather forecast.[ii]
Also underscoring the global weakness was the news that two of America’s largest corporate behemoths – Dow Chemical [DOW.WD] and DuPont [DD] – have agreed to combine in one of the largest mergers in U.S. history.[iii] Though the deal may yield cost-cutting benefits to shareholders, investors largely viewed it as a move to battle darkening global growth.[iv]
All this gloom and doom about the global economy complicates the upcoming Federal Reserve decision about raising interest rates. In August, when a surprise move by the Chinese to devalue the yuan sent shockwaves through financial markets, the Fed declined a rate hike.[v] Now, the Chinese are loosening the yuan again, raising concerns about the health of the world’s second-largest economy.[vi]
Will global woes derail the Fed’s intent to raise rates? We’ll have to see.
Official statements from the Fed have emphasized that the Fed is closely weighing the strengthening domestic economy against global concerns in their rate decisions. Currently, Wall Street odds strongly favor a December rate hike, with one firm putting the probability at 79%.[vii] (Data as of 12/12/15)
In the week ahead, all eyes will be on the Fed’s meeting, and investors will focus on the official announcement and Janet Yellen’s press conference on Wednesday afternoon. Investors will also look carefully at manufacturing and industrial production data to see whether global woes are affecting critical domestic industries.
Tuesday: Consumer Price Index, Empire State Mfg. Survey, Housing Market Index, Treasury International Capital
Wednesday: Housing Starts, Industrial Production, PMI Manufacturing Index Flash, EIA Petroleum Status Report, FOMC Meeting Announcement, FOMC Forecasts, Fed Chair Press Conference
Thursday: Jobless Claims, Philadelphia Fed Business Outlook Survey
Retail sales rise in November. Americans boosted their spending in November, offering retailers hope for the season. Excluding gasoline, whose price has declined sharply, retail sales are up 0.3%.[viii]
Consumer sentiment ticks upward in December. Consumers regained some confidence this month, which hopefully bodes well for the critical holiday shopping season.[ix]
Business inventories flat in October. After a tiny increase in inventory purchases in September, businesses left their stockpiles flat in October as total business sales fell. The weakness could impact growth in the fourth quarter.[x]
Jobless claims jump to five-month high. Weekly claims rose 13,000 last week though the increase doesn’t necessarily indicate worsening conditions. Claims tend to be volatile around the holidays and underlying data remains positive.[xi]
[vii] http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html (Data as of 12/12/15)
The major averages ended last week on a high note despite ongoing concerns about terrorism. Investors kept their cool and gave the S&P 500 its best week of the year.[i] For the week, the S&P 500 gained 3.27%, the Dow rose 3.35%, and the NASDAQ grew 3.59%.[ii]
Terrorism reared its ugly head again with an attack in Mali last week that left 20 dead.[iii] Brussels, the seat of EU governance, went into lockdown on Saturday after authorities found evidence of a planned Paris-style attack on the city.[iv] So far, investors seem to be shrugging off the concerns about terrorism. While cool-headed behavior is good news for investors tired of volatility, it’s a grim sign of the times: People are getting used to tragedies.
In other news, anticipation around the next Federal Reserve Open Market Committee meeting in December is heating up and Fed spokespeople are out in force. St. Louis Fed President James Bullard stated that a rate hike is coming “soon.” [v] Dennis Lockhart, President of the Atlanta Fed, cited improving labor markets as evidence supporting a rate raise.[vi]
On top of the speechmaking, FOMC minutes released on Wednesday showed that the Fed is fully prepared to raise rates in December.[vii] The takeaway: Rate hikes may be imminent. However, we also know that the Fed is very responsive to data. Before making a decision in December, Fed officials will be taking hard looks at the November jobs report as well as taking a look at the global economic situation.
During this holiday-shortened week, investors will be paying close attention to a revised third-quarter economic growth report. The first report showed that the economy grew at a tepid 1.5% in the third quarter. Unofficial estimates are projecting a slight rise in the revised estimate to 1.6% for Q3 and a spike to 2.7% in the fourth quarter.[viii] Will these projections hold? Let’s hope so. Analysts will also be closely watching early reports from retailers for clues about what the crucial holiday shopping season has in store.
Monday: PMI Manufacturing Index Flash, Existing Home Sales
Tuesday: GDP, International Trade in Goods, S&P Case-Shiller HPI, Consumer Confidence
Wednesday: Durable Goods Orders, Jobless Claims, Personal Income and Outlays New Home Sales, Consumer Sentiment, EIA Petroleum Status Report
Thursday: U.S. Markets Closed for Thanksgiving Day Holiday
Weekly jobless claims hold steady. New claims for unemployment benefits remained at 276,000, the 36th straight week below the key 300,000 level. The sustained strength in the labor market could encourage the Fed to raise rates at next month’s meeting.[ix]
Housing starts drop to seven-month low. Groundbreaking on new homes dropped in October to multi-month lows. However, a sharp rise in building permits suggests that the housing market still has momentum.[x]
Wages may be growing faster than we think. A measure of wage growth published by the Atlanta Fed shows that wages grew 3.0% in September, a number much higher than the 2.2% shown by official Labor Department statistics.[xi]
Q3 earnings fall 1.5% from one year ago. With most earning reports in from the third quarter, analysts project that earnings fell last quarter (year-over-year) for the first time since 2009. However, excluding the ailing Energy sector, earnings per share would be up 3.9%.[xii]
Markets gave up gains last week and closed lower, ending the worst week since mid-August. Nerves about a possible December rate hike and faltering commodity prices contributed to selling pressure.[i] For the week, the S&P 500 lost 3.63%, the Dow fell 3.71%, and the NASDAQ dropped 4.26%.
A series of coordinated terrorist attacks shook Paris on Friday, leading to at least 129 dead and hundreds wounded.[ii] Our thoughts are with the victims and their families in this terrible time. Coming on top of suicide bomber attacks in Beirut on Thursday and the possible bomb-related downing of a Russian charter flight in October, the attacks have highlighted the global threat posed by ongoing violence in Syria, Iraq, and Afghanistan.[iii]
American officials were quick to announce that no “credible threat” exists against U.S. targets, for which we are thankful.[iv] As attention turns to analyzing the attacks, experts around the world are already thinking about the financial, economic, and security implications of these new threats.
How will markets react to the attacks?
As always, there is no way to know for sure how single events will affect markets. However, we can take some educated guesses:[v]
- Volatility in financial markets around the world is likely as investors react to geopolitical uncertainty and the expectation that western nations may take a more active role in overseas conflicts.
- Oil may experience a rally as investors hedge their bets against further instability in the Middle East.
- Treasuries and other so-called “safe haven” investments may see interest as investors seek shelter from uncertainty.
- The Euro may drop against the U.S. dollar and other currencies because of increased headwinds.
Though the deplorable attacks are terrible in their human cost, they likely won’t change the overall market calculus for U.S. investors. We will wait and see what happens this week in European markets and will advise you of any concerns as needed.
Looking ahead, investors will be concerned with economic reports and the upcoming December Federal Reserve Open Market Committee (FOMC) meeting. Minutes from the last FOMC meeting will be released on Wednesday, and analysts will be searching for clues about a potential December interest rate hike.[vi]
Monday: Empire State Mfg. Survey
Tuesday: Consumer Price Index, Industrial Production, Housing Market Index, Treasury International Capital
Wednesday: Housing Starts, EIA Petroleum Status Report, FOMC Minutes
Thursday: Jobless Claims, Philadelphia Fed Business Outlook Survey
Retail sales edge upward. October retail sales rose less than expected, growing just 0.1% vs. the 0.3% forecast. A surprise decline in auto sales contributed, tamping down on growth expectations for the fourth quarter.[vii]
Weekly jobless claims unchanged. New claims for jobless benefits remained steady last week, bolstering opinions that the labor market continues to strengthen.[viii]
Business inventories rises. Inventories rose unexpectedly in September, suggesting that third-quarter economic growth data may be revised upward.[ix]
Consumer sentiment rebounds. After losing confidence in September, U.S. consumers regained their optimism in November for the second straight month, mainly on hopes about a strong domestic economy.[x]