Fed Minutes Detail More Rate Hike Excuses, but Hillary Win = Dec Raise?
After another sizzling jobs report in July, it has become more and more obvious that the disappointing number in May was just an aberration in a continued string of steady job creation.
On top of that strong number, average hourly earnings were the strongest in seven years in a year-over-year metric and so far, this year is running at a blistering, nearly four percent pace.
We have spoken throughout 2016 about a Fed that has finally gained an understanding about the stresses that a strong dollar and rising interest rates in the U.S. puts on the rest of the world. And now, these numbers are putting pressure on a Fed that has already backed itself into a corner.
With the latest Fed minutes released today we saw much of the same thing we have seen throughout 2016. Excuse after excuse on why they must wait to raise rates. This is a smart tactic to push expectations on something most in that room don’t want to do until they are entirely sure of a stable world situation. Expect more of the same until after the election.
Our Takeaway…
…on when the Fed will raise: The September meeting rate hike has undoubtedly been put back on the table because of the impressive labor results, but we continue to feel that the Fed will postpone a rise in the funds rate by citing continued concerns from Brexit and the longer term weakness in the labor market conditions index.
Historically speaking, the Fed chooses not to raise rates in a presidential election year, but because of the lead Hilary Clinton holds in the polls, we believe markets have been able to begin pricing in the election results. If this holds and Hilary wins in November, we will likely see the Fed raise rates just in time for Christmas.…on emerging markets: During the last rate hike in December 2015, Asian countries were widely weakening and capital flow was exiting. But we are now seeing GDP growth rates strengthen in Vietnam, Indonesia, Korea, Singapore and Taiwan. This strengthening throughout Asia can’t be seen as a negative for China and because of this we have turned bullish on most of the countries on the continent.
The growing stability in the region only reinforces our view that emerging markets will continue to outperform the developed world, including the U.S., in the near term.
While most will see another rate hike as a negative for emerging markets, we see positive surprises as the most likely outcome due to the continued under allocation to the sector.
…on treasury rates: We believe a long term bottom is starting to form. There have been few times in history that the 10-year treasury rate has been below the rate of hourly earnings growth, and with its continued strength we expect to see in this number, we don’t see how treasury rates can continue to fall.
…on equities: If rates are indeed bottoming here, expect to see the long awaited turn in financials finally start to happen. We are already starting to see breakouts in many regional banks and while large financial institutions should follow, we like the smaller firms and look to play the rise in rates with the nimbler Regional Banking ETF (Ticker: KRE).
…on mREITs: Throughout the year we have continued to advocate having positions in mREITs because of a pullback in rate expectations and a severe book value discount. While the run up in mREITs has been fierce with the valuation discounts shrinking, we continue to believe they are good places to hide on a risk adjusted basis.
We continue to recommend a pair of more nimble companies in the mREIT sector: New Residential Investment Corp (Ticker: NRZ) which because of a stout portfolio of Mortgage Servicing Rights actually prefers a rising rate environment and American Capital Mortgage Investment Corp (Ticker: MTGE), which has the ability to skew its portfolio between agency and non-agency mortgages to take advantage of opportunities.