Wide Spreads Limit Fed Funds’ Rise
Not only does the fed funds futures contract assign a 93% probability to hiking of fed funds at the September 17 FOMC meeting, but nearly 85% of roughly 50 Blue Chip forecasters expect a hiking of fed funds by the end of September. Nevertheless, the latest fed funds futures contract estimates that the effective fed funds rate will barely rise from a recent 0.13% to 0.38%, on average, during December 2015.
Thus, any hiking of the fed funds rate target is likely to be atypically mild. What should remain the dullest economic recovery since World War II merits the mildest tightening cycle for monetary policy since the Second World War. Thus, forthcoming rate hikes are likely to occur at a measured pace. Fed funds may rise at a rate no faster than a percentage point annually by the end of 2016 and into 2017.
Perhaps the fed funds futures market correctly senses that the fed funds rate target may not reach 2% until the end of 2017. An end to a 0% to 0.25% range for fed funds does not necessarily require a normal economic recovery. In terms of both real GDP growth and price inflation, both the current upturn and the next recovery should fall short of each previous business cycle upturn since the Second World War.
Nevertheless, indefinite adherence to a 0% interest rate policy may lead to excessive complacency regarding risk. Already, signs of a return of residential real estate flipping have materialized. In addition, given how costly a nearly 0% fed funds rate has been for small savers, a gradually lifting of short-term interest rates is long overdue. If executed properly, an edging up of fed funds should not be calamitous for financial markets. Global equity markets have effectively told the Fed to go ahead and signal a September 17 rate hike at June 17’s FOMC meeting. The recent worldwide rally by equities despite widespread expectations of a September 17 move suggest that a slightly higher fed funds rate will not trigger an extended and otherwise disruptive slide by share prices. Look beyond lively sequential advances and you’ll find subpar trends All too frequently, the analysis of data focuses too intently on the latest sequential change, while overlooking the broader trend. For example, May’s outsized monthly advances by payrolls and retail sales need to be put in the context of their glaringly subpar performances of the recent past. Notwithstanding May’s addition of 280,000 jobs to payrolls, the US labor market still shows a great deal of slack according to how the 3.33 million jobs created since payrolls’ previous cycle top of January 2008 approximates only 19% of the accompanying 17.84-million person increase in the working-age population. In stark contrast, at comparable points in the previous three business cycle upturns, the same methodology yielded higher ratios of 29% in October 2007, 89% in February 1997, and 99% in October 1988. Today’s low ratio of employment to the working-age population reduces the likelihood of significantly faster wage growth. In May, payrolls approximated 56.6% of the working age population, which was less than each of its moving three-month averages from early 1993 through early 2009, or when the ratio averaged 59.8%. Similarly, the upbeat message of a scintillating April to May advance by retail sales was disputed by a downbeat yearly comparison. Oddly enough, May’s 1.2% monthly advance by retail sales was greater than the accompanying 1.0% rise from May 2014. The meager year-to-year rise underscores how retail sales have yet to sufficiently overcome the deep monthly setbacks of December 2014 through February 2015. During 2015’s first five months, retail sales grew by a lackluster 1.9% year-over-year mostly because of a pricedriven -21.8% annual plunge by gasoline station sales. Granted that retail sales excluding gasoline station sales grew by a faster 4.7% yearly during January-May 2015, but when gas station sales last incurred a comparable, but somewhat shallower, annual contraction during 1986’s second half, the annual advance by remaining retail sales advanced by a much faster 8% to 8.5%. For January-May 2015, the year-over-year increases of only two categories of retail sales stood out relative to trend — the 8.9% annual surge of restaurant sales and the 7.1% annual advance by autodealership sales. Among those categories showing uninspiring sales results were the unchanged year-over-year reading for general merchandise stores, the 2.2% gain of apparel stores, and the 1.9% uptick of furniture and appliance stores. CAPITAL MARKETS RESEARCH 3 JUNE 11, 2015 CAPITAL MARKETS RESEARCH, INC. / MARKET OUTLOOK / MOODYS.COM Credit Markets Review and Outlook A more unequal distribution of income may help to explain why January-May 2015’s 1.9% year-over-year rise by retail sales was so much slower than the accompanying 4.8% increase by wages and salaries. Basically, income growth may have been skewed toward
