INTEREST RATES

LOWER FOR LONGER

Fed Keeps Rates Low, Sees Rise in ’15, ’16 With its bond-buying program winding down, officials are turning their attention to the question of when to start raising the federal funds rate from near zero—where it is likely to remain through the year.

(…) With the job market gradually improving, the Fed is taking away that support and slowly turning its attention to the timing and pace of short-term interest rate increases. It has kept short-term rates near zero since December 2008 and isn’t planning to start raising them until next year.

Investors appeared cheered by that timing. The Dow Jones Industrial Average rose 98.13 points, or 0.58%, to 16906.62 after earlier being down 26 points, while the 10-year U.S. Treasury note rose 12/32 in price to push the yield down to 2.611%.

On average, Fed officials projected the benchmark federal funds rate would hit 1.2% by the end of 2015 and 2.5% by the end of 2016, up slightly from averages of 1.125% in 2015 and 2.4% in 2016 when the Fed last projected rates in March. Over the longer run, officials on average said the target interest rate could settle in at a lower-than-normal 3.75%, down from earlier forecasts of 4%.

Officials also projected the jobless rate falling more than previously thought. They see it receding to 6% or 6.1% by year-end and then to the mid-5% range in 2015 and low-5% range in 2016.

The revisions from March suggest the Fed sees less slack in the economy than previously thought, which could lead to higher inflation and helps explain the slightly higher near-run interest rate projections. Ms. Yellen dismissed as “noisy” recent increases in inflation, though some market analysts said the Fed risks allowing inflation pressures to build as unemployment falls. (…)

“There is uncertainty about what the path of interest rates, short-term rates, will be, and that’s necessary because there’s uncertainty about what the path of the economy will be,” she said.

Underscoring that point, she noted there is a wide range of views even among Fed officials about where rates will be by 2016. Fed forecasts range between 0.5% and 4.25%.

Mohamed A. El-Erian: Fed Dishes Out Continuity

(…) For 2014, the Fed no longer believes that the U.S. economy will recover fully from its first-quarter, weather-induced disappointments. Beyond that, it has joined those worried about the growth potential of the economy. As such, Fed officials have started to concede that the long-term Fed funds rate is likely to settle below its historical level, though they don’t think by much (at least so far). Finally, to the extent that Fed officials worry about inflation, it is limited primarily to movements in prices of goods and services, and the concerns have more to do with “persistently low” rates rather than excessively high ones.

For those of us following closely the evolution of Fed policy, this seemingly steady Fed is one that also has to deal with some pretty large unanswered questions. Consider the following four as an illustration of a broader phenomenon:

• The balance between cyclical considerations, which validate a “highly accommodative stance of monetary policy,” and secular and structural ones that would limit the beneficial impact of such an approach while increasing the costs and risks;
• The extent to which asset-price inflation will serve as a conduit for higher growth and employment, rather than financial instability down the road;
• The ability of macro-prudential measures to counter the risks of bubble-ish markets, overexuberant investors and deteriorating technical market conditions; and
• How U.S. policies will impact the rest of the world in the context of “multi-speed central banking.”

Each of these issues is complex and consequential as a standalone. The whole is materially more so. And all will require a tremendous amount of intellectual and operational agility on the part of the Fed. Fortunately, this was also the first Fed meeting at which the number of governors participating in the policy deliberations is almost complete.

Ms. Yellen says that “the decline in headline unemployment to 6.3% overstates the improvement in the labor market” explaining why the Fed plans on holding rates low even after the rate falls to 5.5%.

The U-rate is now a moving target, no longer THE benchmark as Yellen said that the Fed will now be preoccupied by a large number of indicators. Recall that the U-rate goal post was 6.5% in Dec. 2012 and 7% in June 2013.

Let’s hope that the recent rise in inflation is just noise, as she says, even though the increase was fairly broad based.

As to the overstatement by the lower U-rate, let’s remember two facts:

• The recent drop in the U-rate was not because of a decline in the participation rate.
• The JOLT report indicates that for each job offering, and job openings have spike up in recent months, there are currently 2.2 job seekers, down from 6.8 in 2009 and close to the 2000-2007 range. Workers on the sideline should eventually take notice of the renewed balance in the job market and re-enter. Otherwise, wages could well keep rising, especially given the inflation “noise”.

(http://stateofworkingamerica.org/)

Weak GDP numbers apparently did not dampen labor demand a whole lot, with net gains in jobs posting an 8 month run. Job openings (not able to fill currently)
remained at the highest level in the expansion and plans to create new jobs gained more strength. Although the percent of owners reporting job openings is ten points below the record high, it is holding at the highest level seen since mid- 2007, suggesting that labor markets might be tighter than the unemployment rate
suggests. (NFIB)

Talks that the Fed is behind the curve will reappear in a media near you…

China Housing Slump Hits More Than Homes

China’s housing slump is affecting other parts of the world’s No. 2 economy, hitting everything from construction-worker wages to furniture demand to sales at Yang Limin’s steelyard in this dusty northern Chinese town.

This is typically the time of year when construction companies are at their busiest, said Mr. Yang, manager at Ningxia Yanbao Steel Market Co. But the firm sold only 100,000 tons of steel this year, he said, down 30% from the same period a year ago. In several steel trading offices down the street, several employees appeared to be dozing at their desks.

“It’s already June, and things haven’t improved,” Mr. Yang said. “And next year doesn’t look so good either.” (…)

The latest negative news came Wednesday, when government data showed average new home prices in 70 cities fell 0.15% month-on-month in May, according to Wall Street Journal calculations. That marked the first monthly drop in the measure since May 2012. Housing prices also declined slightly in Shanghai and Shenzhen, suggesting the slump is spreading to China’s most-developed cities, although they rose slightly in Beijing. (…)

PBOC Keeps Pumping Cash

China’s central bank will pump cash into the country’s financial system for a sixth straight week, as Beijing grapples with a still-nascent economic recovery, a sharp slowdown in capital inflows and a decline in foreign investment.

The move to ease funding conditions for banks, the longest of its kind since an 11-week streak last summer, is part of a broader effort by policy makers to lower borrowing costs for businesses and debt-laden local governments.

The People’s Bank of China will inject a net 15 billion yuan ($2.4 billion) into the money market this week via short-term loans to commercial lenders, said traders participating in the bank’s open-market operations that fall on each Tuesday and Thursday. It follows a net injection of 104 billion yuan last week and 73 billion yuan in the previous week. (…)

Vietnam Devalues Dong First Time in a Year to Spur Exports

Brent Rises to Nine-Month High on Iraq Conflict Brent crude traded at a nine-month high as Iraqi forces battled insurgents north of Baghdad. West Texas Intermediate rose for the first time in four days after a government report showed U.S. crude supplies shrank.

WHY IRAK MATTERS

Via ValueWalk:

On Tuesday, IEA’s report forecast that 60 percent of expected growth in OPEC’s crude production capacity in 2019 would come from Iraq.Watch the south:

SENTIMENT WATCH

(Bespoke Investment)

Buyback Binge Surges to New High

(…) Stock buybacks and cash dividends reached $241.2 billion during the first three months of the year, exceeding the previous record of $233.2 billion set in the fourth quarter of 2007, according to S&P Dow Jones Indices. The new high is more than three times the $71.8 billion total in the second quarter of 2009, when the economy was in the early stages of recovering from the financial crisis. (…)

Companies particularly splurged on buybacks during the first quarter. They bought back $159.3 billion worth of stock during the first three months of 2014, up 59% from a year ago and a 23% increase from the fourth quarter. (…)

FedEx Sets Ambitious Targets

FedEx Corp. FDX +6.16% posted impressive fourth-quarter earnings gains and set ambitious targets for the new year despite the challenges at its express business caused by lackluster global trade.

Chief Financial Officer Alan B. Graf Jr. called fiscal 2014 “a good year” despite a third quarter plagued by rough weather. He said FedEx expects 2015 “to be even better.”

He and other executives said FedEx’s restructuring plan is still on track but told analysts on an earnings call that the company had to take different steps than initially planned to achieve the goal of $1.6 billion in profit improvements by the end of 2016. Global trade isn’t improving as quickly as expected, he said.

“It used to be that international trade was a multiple of GDP, and those days have passed,” Mr. Graf said. “We do expect global trade will pick up, but I don’t think it’ll be a multiple of GDP.” (…)

Overall, FedEx posted a profit for the fourth quarter ended May 31 of $730 million, or $2.46 a share, more than doubling from $303 million, or 95 cents a share, in the year-earlier period, which included $1.18 a share in charges tied to a business realignment program and an aircraft write-down. The company had projected per-share earnings of $2.25 to $2.50.

Revenue rose 3.5% to $11.8 billion, above the $11.66 billion projected by analysts polled by Thomson Reuters.

For the new fiscal year, the company said it expects earnings of $8.50 to $9 a share, with the outlook reflecting no expected year-over-year fuel impact along with moderate growth in the economy. Analysts polled by Thomson Reuters projected $8.76 a share. (…)