T’was the season of Christmas and all through the House (Congress that is), shutdowns and interest rates loomed larger than a mouse. With Thanksgiving and Black Friday shopping all done, we are waiting for the Fed to continue the fun. With 3rd quarter earnings far better than feared, we believe that Chair Yellen’s decision is clear…
That’s right, it’s that most wonderful time of year. The Holidays and end of the year economic data, dates and deadlines are upon us. The first important date and subsequent deadline is December the 11th. This is the last date that Congress will be able to make the appropriations decisions on the budget deal that was passed last month. Two of the potential sticking points between Democrats and Republicans are the continued funding (or defunding) of Planned Parenthood and differences on what to do with Syrian refugees. Both of these items could create enough of an impasse in Congress to force another shutdown. It is hard for us to imagine that Senator Paul Ryan, the newly elected Speaker of the House, would want that to happen just weeks after stepping into his new role.
Yes, nothing says Holidays like politics. The threat of another shutdown has gone mostly under the radar, as the Federal Reserves is set to take center stage with its decision on interest rates during their December 15th and 16th FOMC meeting—expectations are that it will raise short-term rates. Fed meeting minutes have indicated that the committee feels the US economy can handle an interest rate increase, and it has seen the continued improvement in employment data that it was looking for to start the process.
Here are a few observations in the event the Fed moves forward. The Fed is looking to raise rates while the rest of the world is looking to cut their respective rates. This divergence in monetary policy could renew dollar strength and once again put pressure on US foreign earnings. Raising short-term rates should increase the interest expense of the US government, whose debt is based off the short-term rate. We expect the market will experience some increased volatility as investors digest the changes.
Historically speaking, US stocks have performed well (on average) prior to and following initial rate hikes, while they are not immune to volatility along the way. Initial hikes typically occur after economic growth has proven itself sustainable, and in our case, the moderate growth comes with low inflation. Additionally, November and December tend to be the strongest months of the year for stocks, which might make it an optimal time to start the process.
As we look forward to next year, a more cautionary view emerges. We are currently observing high yield spreads widen relative to stock market earnings. While much of this is taking place in the energy and materials sectors (given the decline in oil and commodity prices), it is nonetheless a sign that the bond market is pricing in concerns that the stock market isn’t just yet—something that will merit further attention in early 2016. As an election year, 2016 is special in that it takes place at the end of an incumbent president’s 2nd term. Such election years tend to be negative for stocks. Since the mid-2000s, however, the Presidential Cycle has not been a reliable guide to market trends. Regardless, it reminds us of the view we previously shared in our August “Notes” that we could be in the final stages of a bull market. While this last piece of news does give us pause, will are still optimistic for the remainder of 2015.
One quick note on the recently passed budget is that Congress eliminated a Social Security maximization strategy known as “file and suspend.” This strategy allowed couples with different income levels to maximize their social security through the use of spousal benefits. We only bring this up to say that you should be aware of all your benefit options as you prepare to retire, especially as some options are being eliminated. It is a little gift from Congress to “baby boomers” nearing retirement.
With the FOMC meeting less than one week away, pay attention to Chair Yellen and what she might say:
Now dollar! Now stocks! Now treasuries and Congress!
Get ready for higher rates, the data’s upon us!
Growth has been moderate, so rates won’t take flight.
Merry Christmas to all and to all a good night!”