The Market Calm Before the Storm

Janet Yelen Berkeley-Haas

Janet Yelen Berkeley-Haas

Janet Yellen, The Federal Reserve chair, warned investors that the Fed might raise interest rates sooner than they had projected. Investors don’t seem to be changing their activity however.

The U.S. economy continues to perform well and exceed expectations. Yellen warned that the Fed might not keep interest rates near zero while stocks, bonds and currencies continue to keep relatively stable. This stability in trading values reflects investors being complacent about the intentions of the Fed.

Here’s the issue, positive economic signals may speed up the timetable for tighter Fed policy. This would quickly disrupt this stability and ultimately hurt the economic expansion. So the Fed is communicating these expectations, but markets are not reacting, and if the Fed does raise rates, the adjustment would be forced and chaotic.

One positive economic signal is that unemployment has fallen to 6.1 percent from 10 percent just 5 years ago. The Fed plans on ending bond purchases after its October meeting, and estimates full employment at 5.2 percent to 5.5 percent.

The fed funds rate represents the cost of overnight loans, and although many believed it would rise for the first time in eight years, they are starting to doubt that prediction. Yellen made sure to say there is an important element of uncertainty in financial markets, so a firm timeline could not be set. Essentially, if economic indicators are less than expected, rates will stay low, if they’re better, rates will rise quicker.

It seems as though this period of stability shows investor expectations differ somewhat from the Fed and that interest-rate increases will be slower than projected. This shows that investors might not be dependent on the Fed’s guidance. In addition to the stability there is increased risky investment behavior, and that is a sign that investors are confident their projection of the interest rate.


The Fed Expectations – Kathy Bostjancic

Kathy Bostjancic says the Fed is going to be revising down its forecast once again, and also its unemployment rate forecast, and nudging up a little bit its inflation forecast. Most important is going to be the press conference to see what Janet Yellen has to say. She’ll be watching the moving docs on the forecast.

The Central Tendency Forecast was for 2.8 to 3 percent. Her own forecast at Oxford Economics was that is running closer to 2.1%. Certainly the number will be revised towards that lower number. The unemployment rate is at 6.1 to 6.3. Inflation, she expects, will be nudged up a little bit. Inflation is often measured by the PCE which Kathy expects to be between 1.5 and 1.6.

Consumer price data will be part of the discussion. The parties that are more inclined to raise rates will be using the Consumer Price data to support their arguments. Growth in the second quarter should rebound about three and a half percent. Importantly, Kathy notes, that if we can maintain a three percent or faster pace that would be very good news especially if housing got back on track as well.

The asset bubble, risk premiums, term premiums are all very narrow but also worrisome are some of the inflation pressures. The question is how much the long-term unemployed are pushing inflation numbers down. The short-term unemployed are the key variable.

Kathleen Bostjancic Talks with Melike Ayan

Melike -Oxford Econoics, you are an expert on all things nonfarm, and it looks we had you at the right time, last week we had the ECB decision and the nonfarm data came to 217,000 as opposed to Bloomberg’s forecast of 215,000. What was your estimate and are you happy with the result?

Kathy – We’re happy with the result and it was very close to our forecast as well. 217,000, very close to our forecast, roughly the same number as a consensus. I think the big takeaway there is relief that the employment numbers stayed above 217,000. We have stability in the labor force as opposed to the GDP which was quite negative. I think this gives us a good contrast to the GDP number and I think we should put our belief and faith in the employment data.

Melike – How about unemployment, it’s at 6.3% we were expecting 6.4%?

Kathy – It didn’t change much, The official unemployment rate didn’t change all that much, but what we did see is the long term unemployed as a share of the unemployed came down. it still continues to decline, but it’s still too high frankly. It signifies that there is still a lot of unused labor, as opposed to what the official unemployment rate suggests. We are headed in the right direction, the problem is that it is very slow.

Melike – In spite of the cost of living that’s increasing, incomes didn’t increase that much and that was one of the problems with the Bloomberg’s Individual index, we saw the household income decrease, many were concerned about the wages.

Kathy – Whether you are looking for wage number for factory workers vs. supervisory workers, both measures rose a bit. It’s a little above 2%, you’s really like to see that number closer to 3%.


Kathy Bostjancic, from Oxford Economics talks to Melike Ayan, June 6, 2014