United Kingdom Votes on ‘Brexit’ next week

Voters in the United Kingdom will decide on June 23rd whether or not Britain will remain part of the European Union.  This has created a lot of debate within the U.K. and has created a lot of uncertainty in the markets.  A few of the main arguments for “Brexit”, or leaving the EU, is that it will allow the U.K. to better control immigration, free the U.K. from the E.U. regulations and bureaucracy, allow the U.K. to set up its own trade deals, and will save money on yearly E.U. membership fees.  Boris Johnson, a current Member of Parliament (MP) and former mayor of London, is one of the more prominent supporters of the “Brexit”.

Conversely, those wishing to “remain” cite the risks of leaving, which include possible tension and trade barriers between the U.K. and E.U., possible reduced influence in world affairs, and negative economic implications.  The “remain” camp is supported by the British government, U.S. leaders, E.U. leaders, the G20, and the IMF.

Should the U.K. vote to leave the E.U., the market implications are currently unknown, though it is very likely global markets will see some turbulence.  The credit rating agencies would likely penalize the U.K. and their yields would rise.  The largest impact will likely be felt in the Sterling (their currency).  As we have said countless times before, markets can adapt to nearly any scenario, but it is the unknown that causes us to feel the short-term pain.  Should the “Brexit” occur, we would expect some short-term volatility, but holding a diversified portfolio and not trying to outguess or time every aspect of this market remains a solid plan for long-term investors.

Polls had been showing we are in for a very close vote.  Yesterday, Member of Parliament (MP) Jo Cox was assassinated in Leeds, England while campaigning to “remain”.  This caused both sides to temporarily suspend their campaigns.  While it is not known if the assassin was in favor of a “Brexit”, this brutal act will be hard for the “Brexit” campaign to distance themselves from.  Though no polls have come out since the assassination, the markets saw a jump in “remain” probability, now at 69% according to Bloomberg.  This appears to be the most likely outcome in our view as well, though the large number of voters who consider themselves “undecided” can certainly “swing” the vote to leave.

 

The Federal Reserve Leaves Interest Rates Unchanged:

The Federal Reserve met this week and decided to leave interest rates unchanged.  The Fed has been forced to “walk back” some of their comments on raising interest rates in the near future due to the most recent employment numbers. The surprisingly low number of jobs created in May has caused the Fed and economists to question the prudence of raising rates because of the fragmented economic recovery the U.S. is experiencing.  We have seen a mixed picture of the U.S. economy where growth is picking up in certain areas such as home sales, consumer purchases online and capital goods spending, but at the same time we got the weak May report showing job gains are slowing.  The majority of Federal Reserve officials now expect the central bank to raise interest rates only one time this year in either September or December.

“The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up,” the FOMC said in a statement after its meeting Wednesday.  They left the target range for the federal funds rate unchanged at 0.25 percent to 0.5 percent.  This was the first unanimous decision since January.  The vote was 10-0, with Kansas City Fed President Esther George supporting the decision after dissenting in March and in April in favor of a quarter-point rate increase.  The consensus amongst the majority of Federal Reserve Board of Governors is for two quarter-point hikes this year, the number of officials who see just one increase rose to six from one in the previous forecasting round in March, according to projections released by the Federal Open Market Committee on Wednesday.

What is clear from the latest Federal Reserve meeting is that they are not going to raise interest rates unless the economy is clearly strengthening.  Some blamed the Fed for the selloff in the U.S. stock market in January after they raised rates for the first time in December 2015.  We do not agree with that assessment and we would like to see Janet Yellen spend more time discussing the fact that current rates are “abnormal” and they are the result of “extraordinary” measures taken back in 2009 & 2010 to stave off a deeper recession or depression during that time.  She needs to remind the public that the Fed will slowly “normalize” interest rates but they are likely to remain lower than “normal” for many years to come.  The Fed will not raise rates by very much and any small increase will not derail the economic recovery.  The Fed said they were confident that jobs will rebound, saying that it expects “labor market indicators will strengthen.” It said that the “drag from net exports appears to have lessened” and housing has improved,.  They also expressed optimism that business investment will improve as the economy picks up the pace of growth.

The median projection of Federal Reserve officials for the federal funds rate at year-end remained at 0.875 percent, implying two quarter-point increases in the committee’s four remaining meetings. The median long-run projection for the federal funds rate fell to 3 percent from 3.3 percent in March.  All 106 economists surveyed by Bloomberg News expected the Fed to leave interest rates unchanged at the meeting. A separate survey last week showed that analysts projected two rate increases this year, while they were divided over whether the next hike would occur in July or September.

Yellen and her colleagues have wrestled with conflicting U.S. economic data over recent weeks as they pondered when next to lift the federal funds rate. The committee raised the benchmark in December, ending seven years at virtually zero.

As mentioned above, the latest risk factor for global financial markets will come to a head next week when voters in Britain decide on a referendum whether to remain in the European Union.  The FOMC on Wednesday repeated a line from the previous statement that it “continues to closely monitor inflation indicators and global economic and financial developments.”

 

Small Business Sentiment Improves:

America’s small-business owners have gotten slightly more optimistic recently but still have a number of business worries, according to a new report from a small-business trade group.  The biggest issue right now for small business owners is finding qualified workers, according to that report from the National Federation of Independent Businesses (NFIB). Another recently released report, from Babson College, found the No. 1 challenge business owners face when hiring qualified applicants is finding employees with the appropriate skills.  The Babson survey looked at a pool of 1,800 small business owners across the U.S., which included owners from the Goldman Sachs 10,000 Small Businesses program and a comparative random sample of businesses, and found the so-called skills gap was their biggest hiring challenge.  The NFIB report analyzed 700 responses from small-business owners, 48% of whom said they could find few or even no qualified applicants for the jobs they were trying to fill.

The skills gap is one of the consequences of the recession.  This has occurred many times in the past because businesses have to lay people off during the recession and then they can’t find enough skilled workers to hire when business improves. Some argue that small business owners are still nervous about the future of the economy and they not offering high enough wages to attract qualified applicants. It is also increasingly hard to get the attention of qualified applicants because the battle for attention on most social media channels (including job boards) is so overwhelming that it’s a significant challenge to be seen and heard by good candidates. The only way over the noise is to offer more money and many business owners do not have the budget to offer more pay.

In the Babson report, almost half of the respondents said hiring and keeping good employees is one of their top two growth challenges. That report also found that 72% of the respondents had difficulty hiring qualified employees in the last two years. Owners of companies that provide construction services and transportation cited the most difficulty hiring qualified workers.  It’s not surprising that construction businesses have such a hard time hiring skilled employees. More younger people than in the past are going to college so there is a “skills gap” that is making it very difficult to find workers in the construction industry.  Historically, as housing and the economy continue to improve, wages start to rise and more people will be motivated to pursue obtaining the skills necessary to work in construction.

Confidence among U.S. small businesses edged up last month, but business owners expressed growing concerns about weak sales growth. The National Federation of Independent Business’ small business optimism index rose to 93.8 in May from a prior reading of 93.6. Although it was the second straight monthly increase in the index, it remained below the 100 reading in December 2014 and its 42-year average of 98. Worries about anemic sales ranked high among small business owners. 14% of owners said weak sales were their main business problem, up three points from April. Given the pessimism over sales, businesses remained hesitant to increase inventory. There was a decline in the share of owners reporting an increase in inventory as well as those planning to build stocks. “These weak inventory investment readings are consistent with the rather poor performance of consumer spending in the first quarter, leaving owners with excessive stocks and no incentive to add to them,” the NFIB said.

 

Retail Sales Rise:

U.S. retail sales rose more than expected last month, suggesting that economic growth is gaining momentum in the second quarter despite the sharp slowdown in payroll growth. The Commerce Department said retail sales increased 0.5% last month after surging 1.3% in April.  It was the second straight month of gains and lifted sales 2.5% from a year ago. Excluding automobiles, gasoline, building materials and food services, retail sales rose 0.4% last month after an upwardly revised 1.0% increase in April. Nine of 13 major categories showed increases in demand in May, led by a 1.3% jump at non-store retailers, which include online merchants. Sales also rose 1.3 % at sporting goods stores and 0.8% at clothing stores. Automobile dealers’ sales increased 0.5% in May after a jumping 3.1% in the prior month. Stronger consumer spending should provide a much-needed boost to second quarter growth, helping the economy grow at 2.5% this quarter after a .8% pace in the first three months of the year.

 

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