Friday, 10 April 2015

Guest Post: First Quarter Economic Commentary by Dorothy Jaworski

Two brutally cold winters in a row!  By this time, we have all had enough of the cold, the polar vortex, the snow, the freezing rain, the ice, and the potholes that are left on our roadways to harass and frustrate us.  At least we are not in Boston.  We need a change of seasons!

A New Year of Volatility
2015 ushered in a whole new season of volatility in the bond and stock markets.  Stocks have seen a large number of trading days with price changes greater than 1% and coincidentally, the Dow and SandP averages are up year-to-date by about 1%.  Longer term interest rates have moved by large amounts in short periods of time.  Witness the 10 year Treasury note- its yield dropped by 0.50% in January to 1.68%, rose by 0.33% in February to 2.01%, rose to a short term high of 2.21% on March 9th and dropped back to 1.94% for the end of March.  Investment decisions and timing are unusually difficult.  US bonds are also whipsawed every time a geopolitical event rocks the newswires, such as growing Middle East conflicts, ISIS fighting, and the Russia-Ukraine situation.

Speaking of the change in seasons, the Federal Reserve seems determined to begin their own season of change by raising interest rates.  Some Fed officials want to raise rates regardless, saying rates are just too low with an unemployment rate of 5.5% and should be returned to “normal.”  It has been nine years since the Fed last tightened policy in June, 2006; maybe they are getting anxious.  However, some officials, including Chair Janet Yellen, want to keep letting the economy and the data lead them to raise rates if necessary, but to keep rates low if necessary, too.  Just last week, Chair Yellen addressed the slow GDP growth that we have experienced for the past six years of our so-called recovery, which has been anything but “normal.”  She acknowledged studies that suggest that future GDP growth will also be painfully slow due to changing demographics and low productivity.

This slow growth, despite the low 5.5% unemployment rate, would cause the Fed to keep rates at the current low levels for an extended time period.  The studies suggest stagnation much the same as what Japan has experienced in the past twenty years, where zero interest rates and central bank easing campaigns failed to stimulate growth.  Here in the US, short term rates have been at zero since December, 2008 and countless rounds of forward guidance and trillions of dollars of bonds bought by the Fed in QE programs have failed to push our growth rate much above +2.0%.  In 2014, our GDP growth was +2.4%; in the fourth quarter, it was +2.2% with real final sales rising only a measly +0.1%.  The so-called recovery that began in June, 2009 has produced growth rates only about one half of “normal” recoveries since WWII.

Oil Steals the Show
The biggest story of the past year in the markets has to be the plunging price of oil, down 50% in 2014 to below $50 per barrel.  The US has led the world in energy and oil production from its shale and fracking operations.  Suddenly, the extent of excess supply became apparent.  Weak demand for oil from struggling economies in China, Japan, Russia, and Europe, almost assures continued excess supply in 2015.  Falling oil prices, and falling gasoline prices, are like a welcome tax cut for consumers who are saddled with low wage growth and lack of good jobs.  Many people, including myself, thought that the drop in gas prices would lead to higher consumer spending, perhaps even more than the amount they save when filling their gas tanks, but this has not been the case.  Spending has been weak since December and the savings rate has risen to 5.8%, which is the highest since December, 2012.  Energy companies moved to cut production and investment to align to the new $50 per barrel reality and, in the process, would cut jobs.  Since the US is now a larger producer of energy in the world markets, the effects are being felt here at home as well as in OPEC countries and Russia. 

Stock market volatility began after the plunge in oil prices, as fear of the effects on energy companies emerged.  Bonds recognized something else- the reality of falling inflation- and the prospects that inflation is expected to be lower in the next several years.  Year-over-year CPI was flat in February, 2015; there has been only one year-over-year decline since 1955 and that happened at the height of the financial crisis in 2008.  This brings me back to the Fed- slow growth, low inflation- is that a recipe for raising interest rates?  I think not.  But if they do raise rates, they will control short term rates.  Long term rates will still be driven by inflationary expectations and should stay low.  Will the Fed manipulate long term rates by selling some of their accumulated $4 trillion of QE bonds? 

Strong Dollar
While we weren’t looking, the US dollar strengthened by 20% in the past year.  This strengthening is cited as one of the factors that contributed to falling oil prices, since oil is usually denominated in US dollars.  A strong dollar serves to ultimately hurt our exports, and thus our GDP growth, while keeping imports attractive and import prices low.  This is another factor that will be considered by the Fed; a strong dollar will support lower interest rates as demand for US securities increases relative to the bonds of other nations.

So will the Fed raise rates in 2015?  Only they know for sure.  I try not to make bold predictions anymore, because just when you think you can throw a one yard touchdown pass, some guy comes out of nowhere and intercepts it.  Many of the Fed officials keep saying rates should be increased because they want to raise them.  Maybe they will; maybe they won’t.  But I do believe that, if they do, they will be lowering them a few meetings later.  The economic growth we have is too slow and is perhaps unsustainable, wage growth is low, inflation is even lower, and the dollar is strong.  When I enter those key inputs into my formulas, the result is lower rates, not higher ones.  Maybe Janet Yellen’s own words from her speech last week tell it all:  “The tightening pace could speed up, slow down, pause, or reverse.”  If you know what she is going to do, let me know!  Stay tuned!

Thanks for reading!  03/30/15        

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004. She is the author of Just Another Good Soldier, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure.

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