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The Retreat of the Summer Rate Hike

| June 13, 2016
MPCA Weekly Market Update

The S&P 500 Index rallied through mid-week, helped along by dovish commentary from US Federal Reserve Chair Janet Yellen, but cut those gains Thursday and Friday. The index posted a -0.44% return for the week and is essentially flat through the first part of June. The index has gained 3.59% since the beginning of the year. West Texas Intermediate crude prices rose to $49.31 from $48.11 last week, a ten month high. Uncertainty on multiple fronts caused volatility to revisit the market, as the Chicago Board Options Exchange Volatility Index (VIX) rose to 16.02 from 14.48 last week.  Interest rates fell, with the yield on the 10-year US Treasury note sliding to 1.64% from 1.72%.

Janet Yellen was the newsmaker of the week.  In a speech on Monday, the Fed Chair said that new questions about the economic outlook have been raised by recent labor data. Significantly, Yellen dropped a reference to raising rates "in the coming months." Her comments came just days after a disappointing employment report. Additionally, the Fed Chair said that monetary policy is not on a preset course, and that the Federal Open Market Committee will respond to new data and reassess risks to achieve its goals. Markets give a June rate hike exceptionally low odds, and a July hike is now also seen as unlikely.

US government bond yields remain at historic lows. The United States has a relative yield which is greater than many of its European counterparts, and economic conditions are stable but leave many investors anxious about the state of global and domestic growth. Reflecting the need for bond market support, the European Central Bank extended its debt purchase program last week to include the purchase of corporate bonds, to the tune of 80 billion Euros a month.

There was mildly positive news from the labor markets. Last week’s Tuesday Nonfarm Productivity report showed an annualized decline of 0.6% for the first quarter of 2016. This was revised up from the previous month’s estimate for a decline of 1%. Compensation per hour was up 4.2% at an annual rate, versus 2.6% in the prior year, and productivity was up at a 1.3% annualized rate in the first quarter. On Thursday, the June 4th Labor Department data on jobless claims reported an unexpected decrease in first time jobless claims and also reported continuing claims falling to 2.1 million. While the rate at which employers added workers fell for April, jobless claims are still very low as employers have been holding onto their existing manpower.

At the risk of repeating ourselves, hardly a week goes by without a major international organization cutting its global GDP forecast. This week's downgrade comes via the World Bank, which now sees a 2016 growth rate of just 2.4%, down from its 2.9% January forecast. Its 2017 growth outlook was trimmed to 2.8% from 3.1%.

Reflecting the brave new world of zero and negative interest rate policy we find ourselves in, cash is king. Literally. Media reports this week highlighted a shortage of vault space in Europe as banks seek to avoid the 0.40% rate charge by the ECB to keep cash at the central bank.  Banks are looking for vault space in which to store billions in Euro bank notes in order to avoid the charge. The ECB would prefer that the banks loan the cash rather than keep it locked behind closed doors. We remain hopeful that central bankers will someday consider the unintended consequences of their highly experimental actions.

Finally, Switzerland held a referendum on a “universal basic income” last weekend. The notion of sending each adult 2,500 Swiss francs a month and each child 625 — with no strings attached — was soundly defeated at the polls. The idea of a basic income, which would generally replace existing social welfare programs, has been gaining traction of late, with several experimental pilot programs being considered around the world. MPCA withholds comment at this time, citing the parental dictum that silence is preferable when one has nothing nice to say.