Stocks gapped up at the open this morning (Dow +68 pts; SPX +.35%). The SPX is now only .8% away from its all-time high. The energy sector is the clear leader in early trading, up 2%. Healthcare (particularly biotech) is the only sector in the red. So gains are fairly broad-based, from semiconductors to transports to retailers. The dollar is a bit weaker on the day and oil is up yet again. WTI crude is trading up to $50/barrel. Bonds are rising in price, with yields falling. The 5-year Treasury is down to 1.22% and the 10-year is hovering around 1.71%. That’s the bottom of the yield range we’ve seen over the last 4 months. The bond sees a zero chance that the Federal Reserve will hike interest rates this month, and a 20% chance they will hike in July.
At the risk of boring you, I’ll summarize some points from Federal Reserve Chair Janet Yellen’s speech yesterday. She remains “optimistic” regarding the economic expansion, believing that inflation will move gently higher over the next couple of years. She noted oil prices are climbing back from the precipice, and the dollar is weakening somewhat. All the while, domestic demand is strong, helped by an improving job market, housing, and retail spending. GDP should bounce back here in the second quarter, helped by a “significant step-up in spending” by consumers. However, she spent a lot of time discussing risks and “uncertainties.” She said, “Economic developments abroad have significantly restrained” growth here in the US. In addition, business investment has been very weak, even beyond the energy sector. She thinks it is “transitory,” but it is possible that business investment could remain weak. Finally, productivity growth has been “unusually weak,” averaging .5% per year since 2010. And of course, productivity is what drives improvements in living standards over the long term. She doesn’t think this trend is permanent, but isn’t sure. Taking all this information together, Ms. Yellen says the current accommodative stance of monetary policy is appropriate. At the same time, she knows short-term interest rates need to move higher over time. But it seems like the “neutral” level of interest rates is probably lower now than it has been in the recent past. She sort of guided the Fed-funds interest rate to a zero real rate, which means it should be about 1-2% under normal economic conditions. Of course, the Fed-funds rate is currently about .25%.
My takeaway is that she is in no hurry to raise rates, and sees the economy continuing to muddle along. David Rosenberg of Gluskin Scheff agrees and wants to know, “Where exactly is the inflation pressure going to come from?” In his view, Ms. Yellen told us clearly what is going to happen: not until inflation rises to 2% and stays there will the Fed act to raise interest rates. That’s no time soon, he says.
We got a revision to first quarter labor productivity and costs. Productivity remains pretty weak, although we saw an increase in hours worked as well as compensation. On a year-over-year basis, productivity is up .7% and labor costs are up 3.0%. So US labor efficiency is not strong, partly because businesses are not investing in new equipment. But companies are hiring and wages are rising.