June 10, 2016

There have been some major developments in the last two weeks. Let’s begin with the May employment report from last Friday. The report showed only 38,000 in new job growth, compared to expectations of 160,000 for the month of May. This was the slowest monthly increase in over 6 years. As a result, the bond priced immediately rallied, and expectations regarding the next FOMC meeting changed such that the likelihood of a Fed rate increase is now close to 0%. The unemployment rate also dropped from 5.0% down to 4.7% in the same time period, due to people leaving the workforce.

The upcoming FOMC meeting will conclude on June 15th, at which point we will have the official rate decision. As I just mentioned, the market’s expectations now are that there is a near 0% chance that the Fed will raise rates, due largely to the week May employment report. Yellen did say, while speaking at Harvard on May 31st, that a rate increase in the next few months would likely be appropriate, but that was before the dismal jobs numbers were released. That then leaves us with the question – would the Fed actually consider raising rates right into a presidential election, even if the economic data was there to support it?

We finally, and officially, have our presumptive presidential nominees for both major parties. Hilary Clinton and Donald Trump now prepare to face off against each other in the general election, in what will surely be a contest filled with belittling and personal attacks.

Adding additional fuel to the fire is the Eurozone situation, and the potential exit of Britain from the European Union. The “Bexit” vote is scheduled to take place on June 23rd, with the majority of those polled in Britain being in favor of an exit. Yellen stated that Brexit could be the single largest threat to the global economy in 2016 if the vote passes. However, everyone seems to be preparing as though the vote will pass. The Bank of England has already started developing the plans necessary to handle the situation, including possible actions such as cutting rates or increasing quantitative easing in order to support the pound. France has also issued a statement that Paris is ready to fill the void left by London and become a larger financial hub within the remaining Eurozone, although the less than favorable tax regime in France may be a limiting factor.

Additionally, the ECB has begun buying corporate bonds as a part of its quantitative easing program. This is the next step in their plan support the European markets, and it has worked thus far as corporate bond yields in Europe have fallen to their lowest point in nearly 2 years. The average 10-year corporate bond in Europe now yields 1.09%.

So, we now believe, along with the rest of the market, than a June rate increase is off the table. It is going to require both strong economic data over the next 3-4 months, in combination with controlled fallout from a potential Brexit, in order for the Fed to have enough ammunition to consider raising rates again at the end of the year. Then there is also the matter of the US presidential election, and seeing what sort of backlash comes of that process. Regardless of which candidate wins, there are going to be plenty of unhappy voters. Europe also will need to stabilize, or else the Fed will have to more seriously consider the ramifications that a rate increase will have towards the global economy, not just our own.

Eric Swanson, CFA