from the July investment comments from Provident Investment Management
The unemployment rate fell to 4.3 percent in the most recent Bureau of Labor Statistics release. A tightening labor market ought to push wages higher, but average hourly wage growth remains subdued at around 2.5 percent. This keeps a lid on consumer spending and, in turn, also keeps inflation in check.
Low inflation allows the Federal Reserve to maintain its dovish posture. The Fed is being quite slow-footed in its campaigns to raise rates and reduce its balance sheet. The $4.5 trillion balance sheet has been a thumb on the scale favoring borrowers over savers for some time. While the Fed wants to reduce this swollen balance sheet, it is not clear how this can be accomplished without roiling the debt markets, which have been supported through various forms of quantitative easing.
As expected, the Fed raised its target for short-term interest rates by 0.25 percent in June. This was the second hike of 2017 and brings the target range to 1.00 percent – 1.25 percent. The Wall Street Journal’s David Harrison reports that the market is currently handicapping a 50 percent probability the Fed will stand pat at this range for the rest of the year. Yes, we are experiencing a course of tightening, but it is an almost unbelievably gradual one.
Long-term rates have declined fairly steadily in 2017. This downward trajectory appears contrary to the Fed’s tightening activity, but short-term and long-term rates need not always move in the same direction. The bond market has returned to the “lower-for-longer” stance that predominated from the beginning of 2014 until the 2016 elections, where investors almost universally expect rates to increase, yet these expectations get steadily more modest over time.
Low long-term interest rates are good for the housing market. The latest reading for the S&P Case-Shiller index measured national home prices up 5.8 percent on a 12-month basis. Lower rates have also hurt the U.S. dollar, which has declined steadily throughout 2017 compared to a basket of foreign currencies.
This is good news for the stock market. A combination of dollar weakness, low interest rates and robust corporate earnings growth has pushed the S&P 500 to new all-time highs. The market’s rally has been broad, with every sector outside of basic materials enjoying gains during the last month. On a three-month basis, basic materials remain the weakest sector. Next weakest is financials, probably due to the flattening yield curve. Tighter spreads between short- and long-term rates make bank lending less profitable, on average.