The Federal Reserve steps back on raising Interest Rates

Janet Yellen was interviewed by Harvard University on May 27, 2016, to discuss the economy. In the interview, Yellen stated that unemployment rate is close to its goal, but that there hasn’t been much improvement in wage growth or in the number of part timers looking for full time work.  This interview was taken before the release of the May job’s numbers that showed new jobs only grew by 38,000 in the month, which further illustrated Fed Chair Yellen’s point that the labor market has more room for improvement and that we need to look beyond the headline unemployment number and start looking at all the employment data figures to more accurately assess the current state of the jobs market. 

Productivity growth has also been poor but Yellen expects inflation to move back up to the Fed’s 2% target. “It’s appropriate for the Fed to gradually and cautiously increase our overnight interest rate over time,” Yellen declared, most appropriately in the coming months. The tone of her interview, in addition to the hawkish Fed statement released in April, seemed to indicate that the Fed would likely raise rates in June.   We believe the Fed initially wanted to hike rates from the tone of Janet Yellen’s interview and the FOMC announcement in April, but given the horrendous May jobs report, the hike seems all but off the table for now.

 

The May Jobs Report likely to be an anomaly:

The May jobs report released last Friday, seemed to put a dagger in the FOMC plans; only 38,000 new jobs were added in May, egregiously below expectations of 162,000. It would be difficult for the Fed to justify a rate hike in June after such dire news, and based on Fed Fund futures prices, the market currently has a 4% probability of a hike in June and 27% for a hike in July.

 

Oil Prices Stabilizing will help S&P 500 Earnings:

Oil continued to rise in May, gaining 6.93% for the month due to Canadian wildfires curtailing production and militant attacks on Nigeria’s oil pipelines crippling production in the largest oil producing country in Africa. Natural gas prices continued its rise in May, gaining 5.05% for the month. A report by the U.S. Energy Information Administration (EIA) indicated that U.S. natural gas stocks increased by 68 billion cubic feet, less than the expected 69 billion cubic feet.

In June, we will see the remaining companies wrap up their Q1 earnings reports. Unlike May, which was a relatively quiet month in terms of domestic and global fiscal policy decisions, June’s calendar is jam packed with rate decisions: both the Fed and Bank of Japan are announcing any rate changes and/or quantitative easing on June 15, 2016, and the European Central Bank has already announced on June 2, 2016 that they will leave their fiscal policy unchanged as expected. Whichever decision the central banks decide will certainly affect the markets in the short run.

 

Recession Fears Overblown:

Perhaps the best-known market-based indicator for predicting downturns is the slope of the U.S. Treasury yield curve (that is, the yield spread between long-term and short-term Treasuries). Past U.S. recessions have been preceded by a significant “flattening” of the yield curve, in some cases as early as 18 months before the recession begins.

Contrary to conventional wisdom, it is the “flattening” of the yield curve itself, rather than its inversion, that is most predictive of a recession. With short-term rates near 0%, the 10-year Treasury yield would need to drop below 1% to signal a forthcoming recession, or well below current yield levels.

Vanguard’s recession model (see chart below) combines financial variables with proprietary leading economic indicators, a coverage that tends to produce a more reliable signal. Today, the Vanguard model puts the probability of an outright U.S. recession over the next six months at roughly 10%. This outlook is less bearish than is indicated by the financial markets, given the underlying momentum in the labor market. Our model does detect elevated odds of a “growth scare”-a slowdown in job growth-later in 2016.

This is one of the reasons we anticipate the Fed to raise rates to 1% this year and then pause as the pace of U.S. job growth cools. This view is not currently priced in by the U.S. bond market, which sees little if any further tightening in 2016.

The U.S. labor market will not keep lowering unemployment because as wages start to rise somewhat, many people who are currently not motivated to try to get a job will re-enter the labor pool.  We do not expect the pace of job growth to slow as much as the experts are predicting after the May jobs report.  We do think it is possible that the total number of jobs created every month may naturally trend down in total as we get closer to normal unemployment rates.  However, the other factor that is important in this environment is that many people who have taken part time jobs and lower end jobs will actively seek to upgrade their job as well which will impact the numbers.  Therefore, we disagree with many of the forecasters who are predicting that we will see less than 150,000 or fewer jobs per month. If this view is correct, we would anticipate some weaker-than-consensus jobs reports in 2016. We would see such short-term deviations as par for the course as the economy returns to lower trend job growth, rather than a sign of an imminent recession.

 

Umbrella Insurance:

One aspect of the foundation of an overall financial plan is adequate asset protection. Throughout our lives we work hard to earn income and we accumulate a significant level of assets.  Sometimes basic insurance coverage is not enough to adequately protect us from events unforeseen that can end up becoming a major financial burden.  That’s when umbrella liability insurance can help.

Umbrella insurance takes over when your homeowners and auto policies reach their coverage limits.   It protects against personal injury or property damage caused by you, a family member, or a property hazard (known or unknown) which includes items such as pools and trampolines. Umbrella coverage can also help in the event of personal liability off of your property, for example, if a pet dog bit someone and that person sued you.   It covers lawyer fees for libel, slander, wrongful eviction, and false arrest.

The term “umbrella” may be little incorrect in the manner that many people think it covers everything, which it doesn’t. It’s notable to know what would not be covered under an umbrella liability insurance plan. Umbrella liability does not extend into a personal business, including if it’s run from your home. Likewise, it wouldn’t cover those who work on your property, be it a gardener, landscaper, etc. The only time that laborers on your property are insured is domestic work, like a housekeeper or nanny, who works less than 35 hours per week.  Knowledge of what is and is not covered under your umbrella liability insurance plan makes it significantly easier to decide how much insurance you would need.

A cost-benefit analysis is an effective method to figure how much umbrella coverage you should purchase. Typical annual costs are provided below, but there are many factors that affect total cost of a liability insurance policy, including net worth, location, credit score, driving records in the household, number of teenagers in the household, and a comprehensive risk profile.

Premiums paid for umbrella insurance are very affordable for the level of coverage provided.  While roughly 20 percent of people with considerable wealth don’t own liability insurance, about 13 percent of personal injury awards total more than $1 million.  People don’t plan to cause injuries or get sued, but it happens.   That’s why it’s especially important to be covered so accidents don’t drag you and your family into a financial disaster.  The typical recommendation is to have coverage up to your net worth, with $1 million being the minimum.  Figure out how much coverage your current insurance already provides you, and determine out how much you should need in the event of a major liability.

 

This publication is provided as a service to our clients and associates of PFA solely for their own use and information.  The material is derived from sources believed to be reliable but its accuracy and the opinions based thereon are not guaranteed and have not been verified.  The content in this publication is for general information only and not intended to serve as individual investment advice.  You should seek independent advice from a professional based on your individual circumstances.