As we move past the midpoint for 2019, the economic outlook for the US continues to be positive but at a slowing pace, with market watchers focusing on the Fed and interest rate movements as a signal for what might lie ahead. Why are many focused on the Fed and how do markets react to interest rate moves?
The jobs report released on June 7 was much lower than expected (just 75,000 non-farm jobs added in May, which was 100,000 less than expected). Previously announced job gains numbers for March and April were also revised significantly downward meaning that job growth in 2019, while still positive, is significantly lower than it was in 2018. This is as expected because as the economy approaches full employment, job growth should slow down. However, as you reach full employment, wage growth should speed up as employers bid against one another for available workers. But this same job report showed wage growth slowing down (although still in positive territory). Putting all of this together, the conclusion must be that at least for the time being, economic growth (although still very positive) is slowing.
But apparently, bad news on the economic front is sometimes good news for the equity markets, as both the S&P and the DJIA were positive on the day the jobs report was released. What happened? A weak jobs report (or any other weak economic indicator) increases expectations that the Fed will soon start cutting short-term interest rates to bolster continued growth in the economy. Lower interest rates reduce the cost of doing business for companies which enhances their bottom line. And because lower interest rates result in lower bond yields, equities become a relatively more attractive investment option, pushing stock prices higher. Lower interest rates help consumers as well, as it is easier to do that home renovation project or purchase a new car. Consumer spending is a big driver for GDP growth as it spurs economic activity. The general consensus of market watchers based on the June 7 jobs report was that the Fed would reduce rates possibly within the next few weeks but certainly by the end of the year.
However, on June 19, Fed Chairman Powell said that the Fed would leave rates unchanged and did not expect to cut rates this year, although will likely have one rate cut in 2020. And on this same day, once again the S&P and DJIA were positive. In this case, “no news was good news”. By not reducing rates, the Fed signaled that the economy (while slowing), is still in positive territory and growing. The resilience of the equity markets (to both an unexpectedly weak jobs report and the indication by the Fed that a rate cut is not coming soon) should be instructive to investors. Watching one indicator (Fed rate cuts or lack thereof) is not a prudent investment strategy.
As this blog is posted, another jobs report is due and other economic reports will have been released. Will it be “good news” or “bad news,” or does it really make any difference at all?
The underlying lesson in all of this is that it is not possible to predict short-term moves in the equity markets. There are too many factors and focusing on just one (the Fed or a specific economic report) will many times lead investors to the wrong conclusions. Time and time again, the financial markets have proven that investing is a long-term proposition with many twists and turns along the way. The important thing to focus on are your own financial goals and tolerance for market volatility. Try to drown out the rest of the noise around you. Of course, if you have questions about recent economic events or your own financial situation, please give us a call. Our advisors at Atlanta Financial would be happy to talk to you about our perspective and how current economic events might affect you.