What’s in store for interest rates? Your Weekly Update

First, a disclaimer: We’re going to “into the weeds” a good bit more than usual this week.

Regular readers of the Update understand that we believe, as does Warren Buffett, that “the future is unknowable.” That said, this week’s missive discusses what seems to be a prevailing client concern: the future of interest rates.

While we don’t pretend to know the future, there are some interesting things occurring that may impact where rates may be headed—and markets too, at least in the near term.

We hope you enjoy this week’s Update… feel free to pass it along.

Best always,
Lee and Jeremy

P.S. With corporate earnings season right around the corner, we’ll be watching things closely, as usual!


This Week’s Quote:

“In 1977, when I started my first job at the Federal Reserve Board…it was an article of faith in central banking that secrecy about monetary policy decisions was the best policy: Central banks, as a rule, did not discuss these decisions, let alone their future policy intentions.”
― Janet Yellen, newly appointed Federal Reserve Chairperson


JL Davis Thoughts This Week:

The past has proven that actions of the Federal Reserve (the “Fed”) are likely to be the single biggest factor influencing interest rates. Recent comments made by Chairperson Janet Yellen, formal Fed minutes, and published Fed statements themselves are very important to gauge.

The Fed’s most recent statement announced an additional $10 billion reduction in bond purchases (dubbed “tapering”), the third in a series that has reduced those purchases from $85 billion to $55 billion per month. That’s a huge difference, by any measure. At that rate, bond purchases will reach zero in late 2014. Markets seem to be paying attention, and not in a good way.

While the Fed telegraphed “tapering” in past communications, what is somewhat surprising is the apparently new decision to eliminate the longstanding 6.5% unemployment rate target for raising interest rates. Prior Fed pronouncements used a 6.5% unemployment rate as a point of demarcation for raising interest rates, the so-called ”Evans Rule.” At that point, the thinking goes, interest rates can begin to rise in order combat inflation. In an apparent departure, the Fed now says they will look at “a wide range of information” and “readings on financial developments” in setting policy.

Equity (stock) markets have seemed to struggle with the change in communication. U.S. equity markets fell sharply. As we write this, the Fed has now raised their short-term interest rate projections to 1% (from .75%) by 2015. A small increase to be sure. But the 2016 forecast jumped from 1.75% to 2.25%. Taken together, these moves seem to signal a change in the Fed’s thinking.

Adding to the uncertainty were Ms. Yellen’s comments at the press conference following the Fed announcement. In somewhat vague language, she said that the federal funds rate might start to rise about six months after the Fed ends its bond purchase program. Potentially, this means the first or second quarter of 2015, which is well ahead of the December 2015 estimate the Fed has previously communicated. Immediately following those comments, yields on two-year Treasury Notes climbed. Equity markets have responded negatively thus far, which isn’t a surprise from our point of view. Markets don’t like uncertainty.

As for us, we expect interest rates to rise at a measured and modest pace. Though not impossible, a quick upward spike seems unlikely in our view. As for the stock market, we see interest rate uncertainty as potentially a key component of increased volatility in the near term.

The coming weeks begin an important “earnings season” where we’ll be closely monitoring the quarterly corporate earnings reports. As go earnings in our view, so goes the market. Which way is an open question.

We think it pays to be vigilant. Portfolios left to the mercy of the markets face the same risk that investors experienced in the tech bubble of the early 2000s and the financial crisis of 2008. We continue to believe clients need to have a strategy in place that attempts to limit significant drawdowns. If you’d like to discuss your strategy, give us a call.**

Lee and Jeremy
http://finance.yahoo.com/blogs/talking-numbers/222-years-interest-history-one-chart-173358843.html

Market Week: April 14, 2014

The Markets

The wave of tech and biotech selling that has taken the Nasdaq down more than 8% in just over a month spread to the large caps of the Dow and S&P 500 last week. However, the S&P is still only 4% away from the record close it hit less than two weeks ago. Meanwhile, the profit-taking in stocks sent the benchmark 10-year Treasury yield down as demand pushed prices up.

Last Week's Headlines
• Minutes of the Federal Reserve's most recent monetary policy meeting showed most committee members favor expanding the amount of detailed guidance about interest rates after rates begin to rise. The minutes also showed a general consensus that an increase isn't likely for some time.
• Exports from China were down 6.6% in March from a year earlier and imports were down more than 11% over the same time, raising concerns about the implications for the global economy. The customs data followed reports that the World Bank's forecast for Chinese growth this year had been cut slightly to 7.6%, while Chinese Premier Li Keqiang said the economy might not reach its official targeted 7.5% growth rate.
• The International Monetary Fund's semiannual report on its world economic outlook said global recovery is becoming stronger and broader. However, continuing problems in some emerging markets, notably Brazil and Russia, caused the IMF to cut its global growth rate forecast slightly to 3.6% for 2014 and 3.9% for next year. The 2.8% growth rate the IMF projects for the United States this year was unchanged from its January forecast.
• Wholesale prices jumped 0.5% in March; the Bureau of Labor Statistics said the increase could be attributed largely to the cost of services, which rose 0.7%.

Eye on the Week Ahead

As Q1 earnings season gets under way, forward guidance is likely to be just as significant as assessments of how earnings were affected by the weather; as economic data begin to reflect spring, a general failure to show improvement from winter's numbers could be badly received by investors. Also, Wednesday will see the release of China's Q1 GDP figures, which will be closely watched in light of last week's signs of slowing trade.

Data sources: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market data: U.S. Treasury (Treasury yields); WSJ Market Data Center (equities); Federal Reserve Board (Fed Funds target rate); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates). Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks.

The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment

Prepared by Lee Davis** and Broadridge Investor Communication Solutions, Inc. Copyright 2014