Janet Yellen, dubbed a dove by many in the media may be the largest threat to the current bull market. The threat does not come from acting in a way that is contrary to growth, but rather being too accommodating to growth, which can cause our economy to overheat and dip into a recession.
To be sure we are not at the tipping point of action by the Federal Reserve Board (FRB), however the timing of action by the FRB is essential to the smooth transition from an economy propped up by its government and one standing on its own two feet.
If timed correctly, a raise in interest rates would send a shudder through the markets, but the blow would be temporary in nature, perhaps a correction. If the increase is warranted then it is a sign of a strong US economy that needs to start seeing normalized interest rates to slow it down and prevent overheating.
If a raise in interest rates are delayed too long, the bull could get KO’d by the dove. Meaning that if a raise in interest rates are warranted but not acted upon, we could see:
- Runaway inflation
- A lack of wage growth
- Stagnation in consumer confidence and subsequently spending
- Sharp increases in interest rates, causing a fixed income selling spree
- Over leveraged purchasing of equities
- Subsequent sell run on the market as rates are raised quickly to combat the delay
- And a host of other problems that come with the above mentioned…
Conversely, if rates are increased too soon the consumer will not be strong enough to withstand the increased borrowing costs and reduce purchasing. This would lead to a slowdown in growth as consumption slows. Also reduced interest in equity investments as leveraging cost increases against the potential return on the investment.
In conclusion, by no means does Janet Yellen have an easy job! Forward guidance is the FRB policy by which they attempt to be very transparent about the direction they plan on taking. While this method reduces volatility due to its transparent nature, it also may cause major volatility if the FRB needs to change course (as economic data changes) without enough notice to the markets. Forward guidance has interest rates increasing mid 2015 with the ever present caveat that it could change as economic data changes.
Domestic data for the week was mixed with initial jobless claims up slightly, industrial production up, and consumer sentiment down slightly. Nothing that would cause the FRB to change course.
International
China’s industrial production was down slightly. Lending was down substantially from 1.08B to 385B[1] raising concerns about future production.
The Eurozone continued to see weakening data as consumer sentiment fell sharply, largely related to turmoil in Ukraine. Inflation in the EU continued to slide, which should prompt further accommodative action from the European Central Bank. GDP across much of the region slid into negative or flat territory, Germany, Italy (prior week slid into recession), and France.
Japan saw year over year GDP grow at a – 6.8% pace[2]. This is in large part was due to an increase in sales taxes from 5% to 8% that went into effect at the beginning of the second quarter. Their GDP is expected to normalize over the remainder of the year.
For more information:
If you would like an in-depth analysis of your current positions and allocation, please feel free to call Jason Roque at 719-313-7536 to schedule an appointment.
Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment. Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.
[1] www.investing.com
[2] www.investing.com