This week, the Fed, the Bank of Japan and the Bank of England all held
steady on rates. The Fed blamed low inflation and the horrific jobs report
for not hiking rates, erasing their prior hints at raising rates this summer.
The Bank of England held off on rates until the Brexit vote next week. The Bank of Japan is simply running out of bullets, helplessly watching their stock market tank and the yen strengthen. It may be that central banks are running out of arrows in their quiver to make things happen the way they would like.
Thanks to Dent Research, provided here is our weekly information roundup ending the week on June 17, 2016. We hope this information will help you separate the noise from the news. We start each subject with what you hear in the news and finish with what that information means to you.
The Federal Reserve Held Interest Rates Steady, Lowered Its Outlook for
Rates and Economic Growth… Falling employment numbers tripped up the Fed’s plans to raise rates
in June. The central bank now estimates rates under 1% at the end of the
year, and GDP growth of 2%.
What it means – It seems the Fed has never made a forecast that it wasn’t afraid to lower later on. Back in December, 13 of the 17 members expected overnight interest rates of over 1% at the end of 2016. Now, only two members expect rates to be that high. The central bankers see overnight rates at just 1.5% in the middle of 2017, and 2.5% by the middle of 2018. Of course, those forecasts are so far away, they can be ignored or lowered.
As for what happens next, most members think they will raise rates one time this year, taking the overnight rate to a range of 0.50% to 0.75%.
The news sent the dollar down and pushed up the yen. This is the worst possible outcome for Japanese Prime Minister Abe. The only part of his economic policy that worked was devaluing the yen to boost trade and profits. Now the yen has strengthened from 125 per U.S. dollar to 104. Even though the Bank of Japan held rates steady just after the Fed announcement, it will have to take bold actions in the months ahead to weaken the yen.
Consumer Prices Moved Up 0.2% in May, and Increased 2.2% over Last Year… Excluding food and energy, core inflation also grew 0.2% last month, and sits 2.2% higher than last year.
What it means – While the core inflation rate is above the Fed’s 2% target, its preferred measure, the personal consumption expenditure, is still hovering around 1.6%. This report won’t motivate the central bankers to raise rates in July, but there are some interesting components.
Shelter jumped 0.4% last month, and rent rose 3.4% over last year. It’s getting harder to find an affordable place to live.
And health care costs continue their upward march. Health insurance rose 0.5% last month, and is up 6.6% over last year. But this pales in comparison to next year’s expected hike of 10% or more. Don’t worry though. According to the Bureau of Labor Statistics, health insurance accounts for just under 1% of your annual budget, proving once again that these figures are divorced from reality.
U.S. Retail Sales Up 0.5% in May, Following the 1.3% Jump in April… Excluding autos and gas, retail sales rose 0.3% last month.
What it means – Consumer spending has been the one bright spot over the last two months. Inside the report, gasoline sales moved up as expected, but the big gainer was non-store retailers. E-commerce sales jumped 1.3% in May, following the 2.5% pop in April.
This is great news for Amazon, but must have Macy’s and Nordstrom shaking in their boots. On the slow side, building materials fell 1.8%, marking the third straight drop. That’s not a good sign for homebuilders.
Housing Starts Basically Unchanged in May, Still Up 9.5% Over Last Year… Housing permits grew slightly last month, but are down 10.1% over last year.
What it means – Single-family housing starts, which create the most employment, remained steady last month and gained 10.1% over last year. The trend remains intact, but falling permits put the forecast in doubt. Coupled with lower retail spending on building materials for several straight months, these housing figures could indicate a softening market. We’ll get more data on this next week when the National Association of Realtors reports existing home sales and the Census Bureau reports new home sales.
Sixteen Percent of Eurozone Investment-Grade Corporate Bonds Trade at Negative Yields… That’s up from just 5% in May, and reflects the upward pressure on bond prices as the European Central Bank (ECB) starts buying corporate bonds.
What it means – The ECB announced earlier this year that it would expand its scope of bond buying to include corporate bonds, which drove up prices. The central bank started purchasing these bonds last week, which is why prices spiked yet again, driving some yields below zero. Many government bond yields are already negative, but it’s different for corporate bonds. Governments borrow when they don’t have enough revenue to cover expenditures, but corporations typically borrow to fund growth to enrich shareholders. What happens when the simple act of borrowing creates a profit?
In this new world, a company can borrow an unlimited amount of money because it has to pay back less than it receives, so there aren’t any negative implications to high debt. If the company just sits on the cash, it will earn a slight profit, which flows directly to shareholders. Pursuing debt just to capture this arbitrage is absurd, but it works on paper. I’d imagine this is not what the ECB has in mind. This would mean even more money sitting on the sidelines, not chasing goods and services, and not fueling economic growth. Think of it as one more unintended consequence of central bank action.
Chinese Renminbi Drops to Lowest Level Since January 2011… The renminbi touched 6.60 per U.S. dollar, the cheapest exchange rate in more than five years.
What it means – The renminbi does not float against the U.S. dollar. The Chinese government sets the exchange rate, and then allows the renminbi to vary in a narrow band around that rate. So the recent drop in value isn’t a function of market pressure, it’s specifically the Chinese government setting a lower exchange rate.
This isn’t a surprise. The Chinese economy is slowing down, as is world trade. For the biggest exporter on the planet, that’s a problem. They can’t force their population to buy more stuff, and foreigners aren’t spending more either. The one sure way to goose sales, at least in the short term, is to cheapen your currency. This won’t be the last time it happens.
U.S. Industrial Production Down 0.4% in May… The pullback negates most of the 0.6% gain in April. Manufacturing fell 0.4% as well, dragged down by slower auto manufacturing.
What it means – The good news is that mining, which includes oil and gas exploration and production, improved by 0.2%. Unfortunately, that was about the only good news in the report. Consumer goods, business equipment, construction supplies, and every other sub-sector was down on the month. Capacity utilization was 74.9%, down from 75.3% in April. Retail sales might be showing some strength, but so far that hasn’t trickled up to the people that make stuff.
Next Week – The week of June 20 will include reports on existing home sales, new home sales, and durable goods
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