Everything’s Different, Nothing’s Changed

It has been quite a quarter. The U.S Federal Reserve is now on hold, the U.K. has voted to withdraw from the European Union, Puerto Rico has just defaulted on almost $800 million in municipal bond payments, and we are in the midst of the most controversial Presidential election cycle in generations. All of these developments increase uncertainty. Yet after a volatile start to the year, this past quarter’s shockers have left the markets curiously complacent. While these developments do not change our current investment strategy, we think it best to be mindful of the increased uncertainty that surrounds us.

The Federal Reserve is Now on Hold

After months of teasing by Janet Yellen and our Federal Open Markets Committee (FOMC), the Federal Reserve chose to leave interest rates unchanged at their latest meeting and announced that economic and global uncertainties support leaving interest rate policy as is for an extended time. With this latest pass, Janet Yellen, in particular, and the Federal Reserve as a whole has lost credibility with institutional bond traders. These traders will now manage fixed income markets and all longer term interest rates based on their own conclusions brexit millionaire reviews. Currently, futures markets suggest the Federal Reserve is unlikely to raise interest rates again until 2018 at the earliest. It would be dangerous to take a bet on this conclusion, but it does suggest interest rates will now stay low for an extended period of time benefiting home buyers and debtors.

The U.S. economy is over seven years into this cycle and our investment strategy for now is driven by the cyclical trend. Recent indicators confirm that once again winter’s weakness was partly a result of seasonal data adjustments. The latest consumer sentiment reading was 93.5, down from a cycle high of 98 in January 2015, but still on a very positive trend. The most recent Purchasing Manager’s Index (PMI) rebounded to 51.3, again down from this cycle’s high, but still in positive territory above 50. And capacity utilization has slid to just under 75, down from a cycle high of 78, but not so far down from the pre-crisis levels of the low 80s. Finally, existing home sales and even housing starts remain at very healthy levels. All these indicators simply confirm the U.S. economy appears past its cyclical peak, but still on a positive, slow growth trajectory into the foreseeable future.

The U.K.’s Surprise Vote for “Brexit”

It is possible that no one was more stunned than the British people themselves when the voting ended with 52% of the United Kingdom’s voters announcing they would like to withdraw from the European Union. What happens next may not be known for months. Officially, the referendum is not binding on Parliament. To initiate the withdrawal process, Britain must invoke Article 50 of the Lisbon Treaty, and it is implied that Parliament must vote for this move. David Cameron has said he will not invoke Article 50 and will step down in October, delaying a move forward or allowing for a cooling off period, depending on your point of view. There is currently a potential power struggle in Britain as no clear new leader is emerging. There is also the risk that other countries consider similar referendums and that European banks become strained trying to keep credit flowing under an uncertain union.

What is clear is that nothing is likely to happen quickly. European countries, and the E.U. in particular, have a history of moving slowly with measured responses. In contrast, U.S. investors see a problem and look for a timely response. U.S. markets seemed to have quickly bounced back from the Brexit shock, but the real impact of this surprise may take months to fully understand.

The immediate response to Brexit was a quick flight to safety from global investors. Selling in the pound, the Euro and particularly European stock exchanges, flooded the world with liquidity. Most of this cash found its way to U.S. Treasury bonds, considered the safest investment in the world today. The cash inflow pushed the U.S. dollar higher and the yield on our 10 yr. Treasury bond below 1.4%. If the dollar’s strength continues, it may hurt U.S. exporters just as they were breathing a sigh of relief when the Fed announced rates would stay put. Emerging markets were also enjoying a small relief rally from our Federal Reserve’s inaction, as their currencies are generally tied to the dollar. As most emerging markets are primarily export economies, they too, will be hurt if the dollar remains strong.

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