The Fed Needs to Speak with 1 Voice or Not at All
By David Nelson, CFA
38,000 – That’s all we got in the way of jobs in May leaving bulls scratching their head and bears looking for the next shoe to drop.
In addition to creating a roller coaster day for traders, Friday’s weak employment report set off the usual round of conflicting statements from Fed officials adding to an already chaotic atmosphere.
Shortly after the release, Fed Governor Lael Brainard said the report was “sobering” and warned against moving too quickly. Few were expecting a strong report especially in light of the Verizon (VZ) strike but Non-Farm Payrolls coming in at just 38k was well below estimates and confirmed a slowing trend in the last few months.
Just a day later Loretta Mester, Cleveland Fed President added to the confusion saying; “I still believe that in order to achieve our monetary policy goals a gradual upward pace of the funds rate is appropriate.” If the Fed had a communications director they would have been fired long ago. These contradictory statements aren’t helpful and only add to the uncertainty.
The Fed needs to speak with one voice or not at all! – Janet Yellen will be speaking Monday at the “World Affairs Council” in Philadelphia and may give some insight before they go into the quiet period ahead of the June 14-15 meeting. FOMC policy on
External Communications established in 2011 clearly viewed the voicing of personal opinions a violation. However, in January of 2015, probably in response to repeated calls that there were violations, the Fed amended the policy giving Fed officials more freedom. I think history will judge this decision harshly.
Until Friday’s report the probability of a hike in June had been rising but frankly July seemed more likely given the coming Brexit vote at the end of the month. (See last week’s “The Pain Trade is Up”)
Friday’s action, at least in U.S. markets wasn’t the disaster it could have been in given the weak report. At the start of the day I thought we could easily see a down -1.5% for most of the major averages yet SPDR S&P 500 (SPY) closed down just -0.30%.
It was clear that it would be a rough day for banks given the recent run in anticipation of a coming hike but even here there was some encouraging action. At the lows of the day SPDR Financial Select (XLF) was down close to – 2.5% but closed near the high as well as most of the banks on my screen. While June may be off the table I believe July is still live.
Non-farm payrolls is an important look into the labor market but it doesn’t live in a vacuum. The seasonally adjusted US Quits rate shows employees are getting more confident about leaving their job perhaps for greener pastures. We have to be careful not to data mine because it’s very easy to find two sets of data that confirm a thesis even if wrong. However, there does seem to be some correlation between US Quits and the S&P 500 (SPX)
Other data points have been less helpful. Friday showed a big drop in unemployment coming in at 4.7%. Normally this would be good news but with a labor participation rate just above 62% its significance is greatly diminished.
The Fed has struggled with the question of normalization for the better part of a year. Conflicting voices from inside and outside the Fed indicate there is no clear consensus on what path to take. Some have warned that tightening too soon could push us into recession sparking fears of a 1930’s like mistake with a contraction in the money supply adding to the pain. Others believe the Fed is in danger of falling behind the curve and might be forced to play catch up.
Let me suggest there’s a third consideration. At risk of repeating myself, a near ZIRP (Zero Interest Rate Policy) for such an extended period of time has changed corporate behavior. Financial engineering is easily fueled by cheap debt. The never ending stream of stock buybacks to prop up earnings per share becomes even more attractive to management if you can fund it with the issuance of cheap debt. Remember, when a company buys back stock it really does nothing for the bottom line. It only helps EPS because the share count has been reduced.
CEO’s Give Up
Think about it this way. Buying back stock is another way for the CEO to say; “I give up.” It’s a message from management that they aren’t capable of creating new products to attract new customers. The end result is stagnation forcing a contraction in CAPEX starving the economy of needed re-investment capital. I’ve repeatedly penned the next leg of the bull market will be accompanied by increased R&D and CAPEX. Without it all bets are off.
Even with a hike this month or next, rates will still be accommodative. We’re 8 years into the Bernanke-Yellen game plan which I believe is creating unintended consequences. IMHO it’s time to try something different.