Fed's Williams says low neutral interest rates a 'warning sign' | Business News

Fed’s Williams says low neutral interest rates a ‘warning sign’

31 Oct 2015 | Author: | No comments yet »

Is The Economy Just Hot Enough To Trigger A December Rate Hike?.

U.S. government bonds strengthened Friday, but the bond market posted a price loss in October amid strong gains in stocks and anxiety over an interest-rate increase in December. Treasury yields finished October higher after the Federal Reserve hinted at a potential December rate increase earlier this week, leading investors to sell U.S. government debt in favor of assets that are perceived as riskier.

While stock markets posted the best month in four years, short-term Treasurys, which are the most vulnerable to a potential increase in the Fed-funds rate, posted their largest monthly yield increase since February, according to Dow Jones research. The yield on the two-year note, highly sensitive to changes in the outlook for the Federal Reserve’s rate, logged the largest monthly gain since February.

Stocks fell initially following release of the Fed’s statement, a largely balanced view of domestic and global economic uncertainties that the central bank hopes are fleeting, allowing the bank to return to the business of removing easy monetary policy. The Fed took a pass on a rate hike this month, inaction that was widely expected on Wall Street, but leading indexes did rally into Wednesday’s close (Figure 1). Fed statements tend to strike a mixed reaction – investors generally bristle at the thought of losing accommodative policy that has fueled a bull stock market, but they’ve been newly worried in recent weeks that the global slowdown could worsen. On the last trading session of each month, newly minted bonds replace maturing debt in bond indexes, and investors whose bond portfolios track bond indexes closely replicate the changes by buying bonds. Rate-setters struck out a clause saying recent global trends might “restrain” the economy, and upgraded their assessment of household spending and business investment.

Meanwhile, the cost of employing the average U.S. worker also rose less than expected, offering little evidence of a broad acceleration in labor costs. “Most of the data today establish what we knew in the wake of the September jobs report. They also made explicit reference to the possibility of raising rates at their next meeting in December, which some will take as a hint that the countdown has begun. The Fed is close to where it wants to be on its employment mandate, yet still a long way away on price stability at the 2% inflation target level,” said Chris Mier, chief strategist at Loop Capital. Before the turn of the year, though, there will be plenty of new data for the Fed to chew over, including a preliminary estimate of GDP growth in the third quarter of 2015, due to be released on October 29th.

The S&P 500 (SPX), charted on the new-look thinkorswim® platform, closed above 2090 on Wednesday, its highest close since August 18 and back in territory seen before the China-triggered late-August retreat. Bond yields remain at very low levels from a historical standpoint amid weak global demand for goods, contained inflation and highly accommodative monetary policy in Europe and Asia. Now markets are in wait-and-see mode, gauging whether Fed Chairwoman Janet Yellen “is correct that temporary factors — oil prices, import inflation, the high value of the dollar, and weak global conditions — are temporary factors suppressing inflation readings,” Mier said. Interest-rate cuts in China and fresh signals from the European Central Bank about adding monetary stimulus for that region’s economy soothed some fears over the sluggish global economic outlook, encouraging investors to dabble in riskier assets after rushing out over the previous two months.

On Friday, yields declined further after a report showed German retail sales stagnated last month, while inflation in the eurozone in October was unchanged from the year-ago period. But the passage that landed firmly hinted at timing went like this: “In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress-both realized and expected-toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. Fed funds futures, used by investors and traders to place bets on central-bank policy, showed Friday that they see a 50% likelihood of a rate increase from the Fed at its Dec. 15-16 policy meeting, according to data from CME Group.

Another factor containing a rise in long-term U.S. bond yields: much lower government bond yields in many other developed countries, including Germany, the U.K., Japan and Switzerland, which attracted buyers into U.S. debt.

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