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Short Week But Lots of Data Ahead After Yellen Ups Ante on Possible Rate Hike

May 31, 2016

(Tuesday Pre-Market) Fed Chair Janet Yellen capped off Friday with remarks echoing what investors have heard from other Fed officials recently: A near-term rate hike may be in order.

Yellen hadn’t spoken publicly since March, though a number of other Fed officials had made hawkish comments since then. Now Yellen has taken on a bit more hawkish of a tone. The biggest thing she said isn’t only that a Fed rate raise is on the table for the next few months if the numbers bear it out, but that she actually expects the numbers to bear it out, something she hasn’t said before. That’s a big change and may help change the way investors look at Fed rate raises.

Yellen’s exact words Friday at Harvard University were: “The economy is continuing to improve. We saw weak first quarter growth and relatively weak growth at the end of last year. Growth looks to be picking up from the various data we monitor, and if that continues and the labor market continues to improve, and I expect those things will occur, we’ll continue to monitor incoming data and assess risks to the outlook. But it’s appropriate for the Fed to gradually and cautiously increase our overnight interest rate over time, and probably in coming months such a move would be appropriate.”

Immediately after Yellen’s remarks, odds of a rate hike as predicted by Fed funds futures at the Chicago Mercantile Exchange (CME) rose to 34% for June and to 62% for July. Yellen’s comments seem to confirm the general consensus that there’s likely to be a rate hike this summer.

With Yellen’s speech now behind it, the market enters the week following Memorial Day facing a number of data points, some of which may hold significance going into June.

For instance, Friday’s May Nonfarm payrolls report is set to be one of the last big statistical reports before the Fed’s June 14-15 meeting. April’s report had a slightly disappointing headline jobs number of 160,000. As to impact on a summer rate hike, Friday’s data could put the final cherry on the cake, or could give the Fed some pause as it goes into the meeting, depending on how the numbers come out.

And that doesn’t just mean the jobs number, but wage data as well. Wages have been climbing of late, which could suggest rising inflation possibilities. An advance look at prices is due Tuesday, when monthly Personal Consumption Expenditures (PCE) data come out. The Fed is said to keep a close watch on PCE.

Other important data in the coming week include consumer confidence on Tuesday and auto and truck sales for May, due Wednesday. In all, investors could go into the jobs report with a better sense of how the U.S. economy is performing in Q2. 

There’s more to the coming week than data. The next OPEC meeting is scheduled for Thursday. When OPEC last met, members couldn’t agree to freeze production. There’s widespread belief that the same outcome will take place at the coming meeting. U.S. oil rig count fell by two on Friday to 316 despite the higher oil prices, and is down about 50% from a year ago. Crude is now at a point near the $50 a barrel level, which some analysts call a “Goldilocks” area for the commodity, meaning both producers and consumers could benefit from the current price. But the strong U.S. dollar and talk of a possible Fed rate hike, which raises the possibility of further strength in the U.S. dollar, could keep a lid on oil gains, at least for the near term.

Interestingly, despite the stock market’s recent rally to near its April highs, yields on U.S. 10-year Treasury bills remain at muted levels, trading at around 1.85% as of midday Friday, up slightly after Yellen’s remarks. The yield last hit 2% in late January, and it’s getting hard to remember that yields spent most of the second half of 2015 well above 2%. The growing prospect of a summer rate hike, which initially sent the yield climbing, doesn’t seem to be affecting it much now.

S&P 500


The S&P 500 (SPX), plotted through midday Friday on the TD Ameritrade thinkorswim platform, tested resistance around 2096 early Friday before paring gains after Yellen's remarks. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Could Valuations Come Back Into View? The S&P 500’s price-to-earnings ratio (P/E) hasn’t been much of a focus lately, though it remains above historical averages. As of late last week, the S&P 500 had a forward P/E of 17.5, compared with the 15-year average of 16. The S&P 500 sectors with the highest P/E ratios included energy, consumer staples, and consumer discretionary. Telecommunication services and financials had the lowest P/E ratios, well under the average. Right now, the index is facing resistance at the 2096 to 2100 level. If it breaks solidly above that area and stays there for a while, there may be more talk about P/E, considering that the last time the index climbed above 2100, that talk got loud. When P/E ratios rise, it can sometimes make investors a bit nervous about buying into the market.

Consumers Remain Optimistic But Cautious, Survey Shows: Consumer sentiment in May remained strong, though a little below an earlier estimate, the University of Michigan reported Friday in its closely watched survey. The headline number for May came in at 94.7, down a smidgen from the survey’s earlier estimate but still above April’s 89.0 and the May 2015 reading of 90.7. “Despite the meager GDP growth as well as a higher inflation rate, consumers became more optimistic about their financial prospects and anticipated a somewhat lower inflation rate in the years ahead,” said Richard Curtin, the survey’s Chief Economist, in a press release. “Positive views toward vehicle and home sales also posted gains in May largely due to low interest rates.” One interesting note: While investors on Wall Street seem zeroed in on Fed rate policy, that’s not so much on the mind of the average consumer. “The biggest uncertainty consumers see on the horizon is not whether the Fed will hike interest rates in the next few months, but the outlook for future government economic policies under a new president,” Curtin said. “This has increased their emphasis on maintaining precautionary savings.”

GDP Data Still Shows Weakness, But Q2 Looking Up: Though Friday’s second estimate of gross domestic product (GDP) looked weak on its face at 0.8%, it was up from the initial estimate of 0.5%. Corporate profits in the quarter rose 1.9% from Q4, but weak capital expenditures by U.S. businesses continue to drag on GDP. There is a growing belief that the economy could move along at a higher growth level in the current quarter and quarters to come, based on recent data. For instance, the Atlanta Fed’s GDP Now indicator projects 2.9% growth in Q2, up from an estimate of below 2% earlier this month. Economic growth seems to be following a pattern established over the last few years, with weakness in Q1 followed by slow improvement. This coming week, investors could get a better reading into the Q2’s economic picture with Tuesday’s release of Chicago PMI and personal income; Wednesday’s auto and truck sales, and, of course, the biggie, Friday’s May jobs report.

Good Trading,

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