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Shawn-00397_cmykby Shawn Narancich, CFAExecutive Vice President of Research

Green Shoots

 A week chocked full of economic insight concluded with a bang, as a strong jobs report for the month of May provided more assurance to investors that a contraction in first quarter GDP is likely to be transitory. The U.S. economy created a net 280,000 nonfarm jobs last month, nearly a third better than what Wall Street was expecting. Good news on the jobs front was widespread among various industries and accompanied by more evidence that wage gains are firming. After being hamstrung by the West Coast ports strike, an exceedingly strong dollar and another harsh conclusion to winter, the U.S. economy now appears to be gathering speed.

In its attempt to determine the right time to begin raising interest rates, the Fed will triangulate today’s bullish job report with additional evidence of gathering momentum in manufacturing released earlier this week, that coming in the form of an ISM report showing that activity has picked up for the first time since last fall. As well, construction spending perked up in April and previous months’ activity was revised upward. Finally, Yellen & Co. would observe that U.S. light vehicle sales posted another strong number in May, rising to a seasonally adjusted annual rate of 17.8 million vehicles sold, a 10-year high. The plurality of this week’s data reveals an economy no longer in need of unconventional monetary policy and leads us to believe that the Fed will achieve lift-off from zero interest rate policy this fall, most likely in September.

Raise Rates in 2015 … Mais Non?

As investors were digesting the good news domestically, the International Monetary Fund was busy revising down its estimate of how fast the U.S. economy will grow this year. In an unusual move, Managing Director Christine Lagarde urged the Fed to hold off on raising rates this year, arguing that doing so would lead to an even stronger dollar and threaten the rate of expansion globally. The French may be opinionated, but even her admonition is likely to fall on deaf ears. We have said repeatedly that when the Fed raises rates, it will be for the right reasons, and the data we are beginning to see affirm for us that the U.S. economy is rebounding in the second quarter. Like last year, we see a second quarter reversal carrying through with strength into the second half of 2015.

Markets on the Move

Although the IMF might not be convinced, bond investors have responded in dramatic fashion, selling longer dated issues in mass and sending benchmark U.S. rates to their highest levels of the year. Equities in the financial sector are doing the opposite, rallying in anticipating of higher rates boosting banks’ net interest margins. In anticipation of rising rates, we recently increased our weighting to financials, while further trimming our exposure to a consumer discretionary sector that appears closer to full value.

Our Takeaways from the Week

  •  The U.S. economy appears to be perking up, solidifying expectations for Fed action later this year
  •  The bond market is responding, with rates rising to their highest levels of the year