Friday August 26

Stocks fell, rates sold off, and the dollar rallied as Janet Yellen’s comments were interpreted by markets as hawkish. The S&P 500 fell 0.2% to 2,169 and the Dow Jones lost 0.3% to 18,395. Over the course of the week the S&P 500 was 0.7% lower and the dow was 0.85% lower. Utilities stocks today fell more than 2.1% as a result of higher rate expectations, and the KBW Bank index rose 0.7% for the same reason. Stocks initially rose at the start of the day before turning downward after Yellen’s speech. She was upbeat on the health of the economy and said that “the case for an increase in the federal funds rate has strengthened.” These comments come after hawkish comments were also made recently by Bill Dudley and Stanley Fischer in recent weeks. In response to those comments the 10 year Treasury rose 5bp to 1.62%. The 2 year Treasury rose 5bp as well to 0.85%. The spread between 10s and 2s was unchanged at 0.78%. Over the course of the week the 10 year was 4bp higher and the yield curve bear flattened by 6bp which is a fairly significant move. The dollar appreciated in response to rate expectations. EUR fell 0.8% to $1.1195. JPY fell 1.3% to Y101.85. GBP fell 0.5% to $1.3131. Oil prices were for the most part unchanged on the day, as WTI finished at $47.32 and brent finished at $49.67. The market for Fed funds futures now reflects a 38% chance of higher rates in September (was 30% before the speech) and the probability for December is 62%. Data today showed that second quarter GDP was revised downward to 1.1% which was in line with the consensus.

In Janet Yellen’s Jackson Hole speech she came across as hawkish and markets interpreted her comments as conducive to another rate hike this year. Similarly Stanley Fischer of the Fed echoed similar sentiments afterwards. She came short of indicating when that might happen and as usual stressed that further actions will be data dependent. Nevertheless, the possibility for a rate hike as soon as September increased. August nonfarm payrolls will be especially relevant to that decision which is released on September 2. If data continues to show continued improvement in that area and the current trends persist, then look for investors to start to expect higher rates as soon as next month. The Fed also meets in November and December if it does not take action in September. She pointed to consumer spending and the job market as indicators of health in the economy. She indicated that the Fed is still targeting 2% inflation. It is also interesting to note that she addressed monetary policy in the event of downward shocks. Yellen said that the Fed may return to buying bonds in the event of a sudden downturn as opposed to cutting rates further, which could suggest shying away from negative rates as opposed to other areas of the world.

Market based measures for inflation expectations remain very low. In his paper last week John Williams of the San Francisco Fed said that he thinks the natural rate of interest is now around 0.4% higher than the inflation rate, which is significantly lower than the historical level. Markets are pricing in an even lower level, suggesting that interest rates will be even lower than the rate of inflation. This comes from both long term TIPS as well as long term swap rates. For example the fixed rate on a three month swap that begins in ten years is 1.8% which is below what investors are pricing in for inflation.

FT has spent time covering the issues plaguing pensions around the world. These include falling yields and returns in investments, unfunded liabilities coupled with lower contributions and aging populations. Defined benefit pensioners have received promises to earn a fixed pension, and there is a shortfall to what they are owed. Defined contribution pensioners have not received any guarantees and are at risk of not having enough income in later years of life. Investors in younger generations will need to save more and rely on their own savings and investments as opposed to pension plans from employers.

Friday August 26

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